When You’re Planning for Retirement, Is It Worth Looking into a Target Date Fund?

In Finance, Retirement by SamLeave a Comment

So many Americans struggle with the concept of planning for retirement. Even if they want to start saving, they might not know where to begin. Some people put it off too long, or they may be struggling to make ends meet, making retirement a low priority.

With that being said, many Americans find that they’re in a difficult position when approaching retirement. According to CNN, 21 percent of Americans have nothing saved for retirement, and a third have less than $5,000 in the bank. Needless to say, many source agree this is too little.

To have a comfortable retirement, people should start saving as soon as possible. There are plenty of options to consider such as an employer-sponsored 401(k) plan or another tax-advantaged fund like a Roth IRA or a traditional IRA. However, there’s another option that deserves some consideration: a target-date fund.

What Is a Target-Date Fund?

Investment companies sometimes offer target-date funds, which are structured in a way that helps people meet their financial needs at a point in the future. A target-date fund is designed to grow assets over a set period of time and ultimately meet a targeted goal. A target-date fund evolves in terms of risk based on how close the time is to that targeted date.

For example, if the target-date is retirement, then the fund becomes more risk averse the closer it gets to that time. The overall concept is based on traditional portfolio management theory, and the asset strategy is based on risk tolerance over time.

A target-date fund is a long-term investment. When one of these funds is created, it initially has a high risk tolerance. This means that it’s weighted more heavily in favor of higher-risk assets. The portfolio’s assets will probably be rebalanced every year. Over time, and as the target date approaches, the allocations are going to be weighted more significantly in the direction of low-risk investments for fixed-income investors.

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If you are planning to invest in a fixed-date fund, you look at the year that’s in the name of the fund. For example, if someone is going to retire in 2040, the fund will have that date in the name.

Even if a target-date fund has the same end date as another fund, it can vary significantly in asset allocation and investment style. For example, one fund might include only index funds rather than individual securities. There are also differences regarding expenses.

Why Should You Consider Investing in a Target-Date Fund?

As with any financial product or account, both pros and cons come with target-date funds. The following are some advantages:

  • This is a low-maintenance investment product that’s great for long-term passive investors. These funds are intended to work well for all investors.
  • These portfolios are professionally-managed, which is again a benefit if you’re looking for something that’s effortless and good for a passive investment approach.
  • There is a low barrier to entry with most target-date funds, making it a viable option for many people who want a diversified portfolio.

What Are the Cons of Target-Date Funds?

Potential downsides of target-date funds can include:

  • A one-size-fits-all solution isn’t going to be tailored to your individual needs, goals, and interests.
  • Most target-date funds do have higher expense ratios. This is because there’s a fee for managing the fund as a whole, but many of the mutual funds included in the target-date fund also have their own fees.
  • It’s possible that a target-date fund can lead to a portfolio that’s not well diversified.

Conclusion

Some investors may be better suited to target-date funds than others. For example, younger investors might be more inclined to invest in a target-date compared to older investors. It provides younger investors with a hands-off approach to building a portfolio, and younger investors might like this overall sense of simplicity.

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At any rate, how you save for retirement is an important and personal choice. There are many options, and a target-date fund is just one to choose from. Carefully review your financials before making any investment decision that involves retirement.

Article by Andrew from LendEDU – a consumer education website. Check out the blog if you want to read more on retirement.

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