Is a Target Date Fund Right for Me?
What is a Target Date Fund?
A Target Date Fund is a type of mutual fund designed to help investors save for a specific goal (typically retirement). When you invest in a Target Date Fund, you choose the year that you plan to retire (an approximate guess is fine), and the fund is managed according to that timeframe.
As a general rule of thumb, if you have a longer time horizon, you want to pick more aggressive investments. You have time to withstand the inevitable ups and downs of the market. If the market takes a big dip, it’s not necessarily bad if you aren’t looking to sell your investments anytime soon.
However, if you have a shorter time horizon (are planning to retire soon and will need to start selling some of your investments), it makes sense to be more conservative and pick investments that have less risk of a major dip.
With a Target Date Fund, your money will be invested more aggressively (higher risk/higher potential returns) when you are starting out, and it will automatically be rebalanced with more conservative investments as you get closer to your goal date. Over the years, your higher-risk investments will be sold and replaced with lower-risk investments.
A Target Date Fund helps ensure that you are diversified in a way that is appropriate for your age (or for how far off retirement is).
Reasons to Consider a Target Date Fund
Selecting the right investment option or investing strategy is very personal. What’s best for you, may not be right for someone else, so it’s important to understand the reasons behind your selection.
Prevent Analysis Paralysis
Trying to pick the ideal investments for your retirement account can be overwhelming. Without being able to predict the future, there is no way to ensure you are making the ideal choices. When you add a lack of understanding of financial jargon to the mix, it’s understandably overwhelming to decide how to invest. This feeling of overwhelm often causes analysis paralysis. Fear of making the wrong decision can lead to making no decision.
While the Target Date Fund offered by your 401k or IRA provider might not be the perfect investment mix for you personally, in most cases it’s a great “good enough” option. If picking a target date fund now allows you to stop putting off opening a 401k, it is almost certainly better than waiting another 3 years until you find the time to sufficiently educate yourself on investment strategies.
Hands off
Once you pick a Target Date Fund and establish a plan for contributing to it, you don’t need to do anything else. The Fund will be automatically rebalanced (selling some certain stocks, and buying more of others) over the years to ensure that your money is appropriately diversified and has an appropriate level of risk for your age.
Aside from saving you time, having a hands-off approach to investing may also prevent you from making emotional or reactionary investing decisions.
Drawbacks of a Target Date Fund
While a Target Date Fund is a great option for a lot of people looking for a hands-off approach to long-term investing. There are some drawbacks or limitations to consider.
Cost
The Target Date Fund manager charges a fee for the service of having your investment rebalanced for you. Typically, Target Date Fund fees are not exorbitantly high (compared to some other actively managed mutual funds), but compared to investing exclusively in Index Funds or Exchange Traded Funds, a Target Date Fund is going to cost you more. When it comes to long-term investing, fees can really add up.
Lack of Customization
More experienced investors may prefer managing and selecting their own set of investments so they can have more control over the specific type of investments or diversification in their portfolio. A Target Date Fund is aimed to served the best interest of a wide audience. While many people will be well served by that, some people may have specific preferences or needs that fall outside of the Target Date Funds investment approach.
For example, if you are committed to socially responsible investing, you may be trying to actively avoid owning stock from certain industries (tabbaco, oil, etc) or from specific companies that don’t meet certain ethical standards. With a Target Date Fund, you won’t have the ability to control which specific companies or industries you are invested in, so you may decide it’s not the best option for you.
This is for informational purposes only. It is not intended to be specific investment advice. If you are not sure what investment strategy is best for you, speaking with a Certified Financial Planner can help you determine the most appropriate option.
