There are many investment options out there for retirement plan participants, making your asset selection process time-consuming and confusing. However, one type of investment that has been gaining popularity over the past few years is target-date funds or TDFs. You might be asking, what exactly are target-date funds? Target-date funds are a mix of assets based on an individual’s number of years until retirement, also known as the target date. Fund managers will choose the investments and automatically reallocate your portfolio to become more conservative as your target date approaches.
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Although there are many supporters of this fund, it’s important to remember that there is no one-size-fits-all approach to investing. Before you join the bandwagon of target-date fund enthusiasts, make sure you understand the factors that come into play when using this type of investment. The more you know about target-date funds, the easier it will be to determine if they are right for you.
Here are some advantages to using target-date funds:
- Automatic allocation adjustments offer ease for people who lack time or interest when it comes to their investments.
- Investing in one fund, rather than many, is easier and can be less stressful for people.
- Statistics show that people who use target-date funds tend to stay with this investment longer than those using other core investments offered in their retirement plans.
Here are some disadvantages to using target-date funds:
- Higher fees than other investment options.
- Not all target-date funds are created with the same end-goal in mind. There can be substantial differences even between two target-date funds with the same target year based on the equities blend, asset classes, sectors and other fund categories the manager uses in a fund.
- A target-date allocation model will assume the same risk tolerance for everyone, even though each investor is different.
Through and To
Know the difference between allocation models that offer “through” funds and models that offer “to” funds:
- “Through” funds are geared toward investing “through” your target date, which means your investment strategy will take more time to get conservative.
- “To” funds are geared toward investing “to” your target date, which means your investment strategy will get conservative sooner.
If you do decide to use target-date funds in your retirement portfolio, you must understand that the funds will not do all of the work for you. You might discover that your assets are not as conservative as you thought as you get closer to retirement. Therefore, although target-date funds provide ease for more hands-off investors, investors still need to research the conservative path of a target-date fund to know whether it fits their own conservative strategy. To help you determine your ideal allocation mix, consider taking an asset allocation test or using online calculators.
There is no such thing as a perfect, one-size-fits-all investment. Retirement saving doesn’t come easy, even with options that are known to be effortless and simple. With a little bit of education and involvement, you will be able to determine if certain investments, such as target-date funds, are right for you.
Scott Holsopple is the president and CEO of Smart401k, offering easy-to-use, cost effective 401(k) advice and solutions for the everyday investor. His advice has been featured on various news outlets, including FOX Business, USA Today and The Wall Street Journal.