Target Date Funds

Target date funds, also known as life cycle funds, are an investment option for saving for retirement. They’re mutual funds or exchange-traded funds that are often a default investment option inside of 401(k) plans. Target date funds can help investors who aren’t sure how to start investing for retirement or struggle with investing strategies.

How Target Date Funds Work

Target date funds invest in multiple securities such as stocks, bonds, and others to create a diversified mix of assets. They’re often used as a retirement savings tool to help individuals stay invested during their working years. In terms of how they work, investors choose a target date fund based on the date or age they plan to retire. The target date fund also rebalances and optimizes asset allocation so the investor doesn’t have to worry about doing it.

With target date funds, the goal is usually to have a mix of assets that align with an investor’s time horizon. For instance, if a working professional has 40 years until retirement, their initial portfolio mix would likely comprise heavily of stocks. As the individual nears retirement, the asset mix would likely become more conservative and hold more bonds, CDs, cash, and other fixed-income investments with less risk. Once the investor is close to retirement, the target date fund would aim to minimize risk and protect the nest egg that’s grown over the years.

As mentioned, target date funds can be found inside retirement plans like 401(k)s. They’re also used for college savings, including 529 plans.

Target Date Fund Strategies

Target date funds can be used in three primary ways: actively, passively or hybrid. The approach chosen hinges on the investor’s preference. While some people prefer a hands-off approach, others may prefer to be more involved in the asset management process.

• Active: The primary goal of the target date fund is to outperform the market. Thus, active portfolio managers select actively managed investments.
• Passive: the target date fund is managed passively, and the goal is for the fund performance to mirror an index, like the S&P 500.
• Hybrid: This approach is a blend of active and passive investing.

Advantages and Disadvantages of Target Date Funds

One advantage of target date funds is that they can take the hassle out of creating an investment strategy. They’re also flexible since investors can switch target date funds if their retirement timeline changes.

A downside is that funds can have relatively high expense ratios, which chip away at investment earnings. It’s important to compare expense ratios between target date funds to ensure you’re getting the most cost-effective deal. Another downside is that target date funds may not maximize your returns since they become less aggressive over time or can be too conservative. This means potentially missing out on gains during a bull market.

That said, they can be a good investment strategy for people who have a long horizon until retirement or beginner investors. If you need help investing in a target date fund, one of our finance professionals can help.