Target date mutual funds have become popular retirement savings vehicles and are commonly found in 401(k) plans and other employer-sponsored retirement plans. But are these mutual funds right for you and your retirement goals? Find out how target date funds work, and you'll know whether they're smart investment choices for you.
- Target date mutual funds combine many different assets, aimed to reach retirement or savings goals by a set time period.
- Target date funds are best suited for investors who know when they plan to retire, and prefer a simplified and automatized process.
- Target date fund portfolios are allocated without much regard for individual preference or risk, but rather by preset standards and formulas.
- You have many options in target date mutual funds, so be sure to look for low expense ratios, high diversity, and good long-term performance.
What Are Target Date Funds?
Also known as "lifecycle funds," target date funds are often mutual funds that invest in an asset mix of stocks, bonds, and other investments. What makes these funds unique, compared to other balanced funds, is that the asset allocation gradually shifts over time in a way that is appropriate for investors retiring during a certain target year or decade.
Example of How Target Retirement Funds Work
For example, a target date 2050 fund would invest in a way that is appropriate for someone who expects to retire in about 30 years. Since the target date is so far in the future, the asset allocation could be 80% stocks and 20% bonds. By the year 2050, it might be the opposite—20% stocks and 80% bonds.
Are Target Date Mutual Funds a Good Fit For You?
Investors who may benefit most by investing in target date funds are those who are looking for:
- Simplicity: It's not uncommon to be confused about how to transition one's asset allocation over time so that it is ready for retirement as the target date gets closer. Target date funds simplify the investment process so investors don't have to do any research or other investment management. Some investors do not have the desire or the time to learn how to build a portfolio of mutual funds for retirement.
- Diversification: Target date funds are often composed of a diverse selection of mutual funds, making one diversified portfolio in just one fund.
- Automated investing: By setting an appropriate asset allocation for a stated retirement date, and by slowly reducing stocks and increasing bonds over time, the target date retirement fund does all of the asset allocation and investment selection for you.
- One-fund solution: Target date funds can be considered an all-in-one retirement planning solution. If not for any other reason, the most ideal candidate for target date retirement funds is the investor who has most or all of their retirement savings in one account, such as a 401(k) or IRA.
Target Date Funds Are Not for Everyone
Although target date funds have many benefits, they are not the ideal investment choice for everyone. For example, an asset allocation of 80% stocks and 20% bonds might be appropriate for someone who will be retiring in 30 years, but it might not be appropriate for an investor with low tolerance for risk.
Managers of target date funds assume a "one-size-fits-all" portfolio structure, meaning that they will invest the same way for all shareholders of the fund. When choosing the most appropriate investments, there are many variables to consider, such as life expectancy, risk tolerance, and existing funds you might already have in your portfolio.
Your own risk tolerance can be influenced by both your personality and current financial situation. As finances change over time, your tolerance for risk might change as well, in spite of how you relate to money on a personal level. Risk tolerance is worth reassessing from time to time.
The Best Target Date Retirement Funds
Similar to selecting other mutual funds, the best target-date funds will be those with a combination of below-average expense ratios and broadly diversified portfolios and average to above-average long-term performance.
Here are the mutual fund families offering the best target date retirement funds:
- Vanguard Target Retirement Funds: Not only has Vanguard been offering its target retirement funds for more than 15 years, but it also uses its index funds as underlying holdings for each portfolio. Therefore, investors who use Vanguard target funds are assured at least "average" returns with broadly diversified portfolios. The king of low-cost index funds is a natural choice for one of the best target date mutual fund families. Vanguard's target retirement funds average 0.12% expenses, whereas the average target date fund averages 0.63%.
- Fidelity Freedom Funds: Similar to Vanguard, Fidelity has a solid selection of low-cost mutual fund, and its Freedom Funds uphold that tradition. Fidelity has been offering target-date retirement funds longer than most other mutual fund companies, and its long track record illustrates its skill in building low-cost, broadly diversified portfolios.
- T. Rowe Price Target Date Funds: Historically, the target retirement funds at T. Rowe Price have been good performers, compared to their category peers. However, their allocations have been more tilted toward stocks. That typically makes for greater performance, which can be a prudent goal in the early years of retirement saving. But the higher relative risk (and lower returns in down markets) may be too volatile for some investors with low risk tolerance.
Target retirement funds, also called "lifecycle funds," can be smart investment choices for retirement savings because of their key benefits, such as simplicity, diversification, and automated shifting of allocation over time. However, target date funds might not be ideal for every investor. Be sure to study how these unique funds work prior to investing.
Disclaimer: The information on this site is provided for discussion purposes only, and should not be misconstrued as investment advice. Under no circumstances does this information represent a recommendation to buy or sell securities.