Target Date Funds: A Beginner's Guide to Investing

Target date funds are a type of investment vehicle designed to help you save for retirement.

They work by gradually shifting your investments from more aggressive stocks to more conservative bonds as your retirement date approaches.

This means you don't need to constantly monitor and adjust your portfolio.

A target date fund can be a great option for beginners who want a hands-off approach to investing.

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Target date funds are designed to help manage investment risk, and they do this by gradually shifting the mix of securities and asset classes as the target date for needing the money draws near. This shift is called a "glide path", and it's a key feature of these funds.

A fund's glide path is designed to reduce investment risk over time, but it can vary considerably from fund to fund. This means that even if two funds have the same target date, they may have very different investment strategies and asset allocations.

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Most target date mutual funds invest in mutual funds or ETFs to gain the desired exposures. This is because these funds offer a way to invest in a broad range of assets with a single investment.

A target date series is made up of several target date mutual funds issued by the same firm, each with a different vintage (e.g., 2025, 2030, 2035, etc.). You select the vintage that is closest to the year you plan to retire or need the money.

Here's a rough idea of how the glide path works:

As you can see, the allocation to equities decreases and the allocation to fixed income increases as the target date approaches. This is the general idea behind a glide path, and it's a key feature of target date funds.

Target-date funds work on the principle of asset allocation, which means they invest in different assets such as stocks, bonds, cash, and alternative investments according to your objectives and risk tolerance.

As you get closer to retirement, it makes sense to shift your portfolio to assets that are historically less risky, such as bonds and certificates of deposit. This is because you'll want to preserve your capital and generate income, rather than taking on more risk for long-term growth.

Most target-date funds are structured as mutual funds, which means they invest in other mutual funds rather than individual securities. This is often referred to as a "fund of funds" approach.

The investment mix in a target-date fund will change over time, becoming less focused on growth and more focused on producing income as the target date approaches. For example, if the target date is a long time from now, the fund will be more heavily weighted toward stock investments, but as the target date gets closer, it will shift to more fixed-income or cash equivalent investments.

A portfolio manager will make trades based on a tool called a "glidepath" to adjust the underlying mix of investments in the fund. This glidepath is like an investment flight plan, helping to determine the risk exposure over the course of your path through retirement.

As you get closer to retirement, the fund will move toward lower risk options, such as bonds and treasury securities, which aim for capital preservation and/or income.

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When investing in a target date fund, it's essential to consider the fees associated with the fund. A small percentage difference in fees can add up to a big dollar difference in the returns on your mutual fund, so be aware of all the fees associated with any fund you invest in.

You can compare the fees and expenses of different funds using FINRA's Fund Analyzer, which can help you make an informed decision.

An outsized holding of stocks or bonds elsewhere in your portfolio can increase your weighting in those asset classes overall, either magnifying or offsetting the impact of the target-date fund holdings.

It's also crucial to monitor the fund's performance and assess whether its investments continue to meet your needs and risk tolerance over time.

Here are some key points to consider:

If you hold a target-date fund outside a tax-advantaged account such as a 401(k) or IRA, be aware of the tax consequences, including taxable income from interest, dividends, and capital gains distributions.

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Many people buy target-date funds through an employer-sponsored retirement plan, and the choices may be limited when it comes to the funds available.

Target-date funds with underlying index investments tend to charge lower fees.

Fees can vary widely, and one factor that may determine them is whether the stock and bond segments are actively managed.

A 12b-1 fee can drive up costs over time, so it's essential to check if the fund has one.

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Target date funds have some amazing benefits that make them a great option for many investors. Automatic adjustments are one of the biggest pros, as the fund's asset mix is automatically adjusted over time to become more conservative as the target date gets closer.

This means that you don't have to worry about constantly rebalancing your portfolio, which can be a huge time-saver. By having an all-in-one portfolio, you can have confidence that your investments are aligned with your goals and risk tolerance.

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Here are some key advantages of target date funds:

Target date funds offer many advantages, including the ability to help people get invested in a diversified portfolio that's aligned with their investment horizon.

Longevity risk is a major risk that target date funds can help manage by investing for growth potential, ensuring that your investments keep up with inflation and potentially grow beyond that.

Market risk is another risk that TDFs can help manage through diversification, holding a wide range of investments to smooth out periods of volatility in the market.

Diversification and asset allocation don't guarantee a profit or protect against loss, but they can help minimize the impact of market downturns.

Target date funds' allocations to stocks help manage inflation risk, as stocks have historically outpaced inflation over long periods.

TDFs may also hold other investments that protect against inflation, such as real estate investments, commodities, and Treasury Inflation-Protected Securities (TIPS).

Target date funds' diversification strategies also protect against deflation risk, the risk that prices begin to fall due to reduced consumer spending and a slowing economy.

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Target date mutual funds have some great advantages, starting with automatic adjustments that ensure your asset mix becomes more conservative as you get closer to your target date. This means you don't have to worry about rebalancing your portfolio.

One of the best things about target date mutual funds is that they can serve as your sole fund in a portfolio, eliminating the need to select several funds to create a similar asset allocation mix.

However, there's a catch – you don't have the ability to adjust allocations if your risk tolerance changes, which might not be ideal for some investors.

Target date mutual funds are designed to meet your needs through retirement, but there's no guarantee that the funds will generate the income you need, which can be a concern for some.

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To choose a target date fund, start by picking a retirement target date, which is the approximate date you plan to start withdrawing money. This is as simple as answering one question about your milestone: when do you plan to retire?

An investor selects the target date mutual fund vintage (year) that is closest to their expected retirement or target date. This is usually done by choosing the fund with the name closest to the date you plan to retire.

A target date fund's mix of assets will either remain static at expected retirement (a "To" fund) or continue to change through expected retirement (a "Through" fund) becoming more conservative and income-oriented.

Consider how much risk you are willing to take when comparing funds with similar target dates. Examine their investment strategies so that you can select the one that best matches your tolerance for risk.

Here are some factors to keep in mind when choosing a target date fund:

Your employer may have automatically enrolled you in a target date fund in its defined contribution retirement savings plan. Take time to understand the fund and consider whether a different option in the plan might be better suited to your retirement savings needs.

Target date funds are a great option for retirement savings, but it's essential to remember that they're not a set-it-and-forget-it investment. You should check in on them from time to time, especially after a big life change.

Monitoring your target date funds regularly can help you determine if they still fit into your overall investment strategy. For those who plan to retire at a standard time, target date funds can be a one-size-fits-most approach. However, for those who break the mold, it's a good idea to meet with a financial advisor to help evaluate your financial plan and make adjustments as needed.

Diversification is a key strategy that target date funds use to address market turbulence. By investing in multiple types of assets, the fund can help reduce the risk of significant losses. This is achieved by blending different investments together to give you a smoother journey, much like how bonds tend to perform well when the stock market is weak.

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Diversification in TDFs is an investment strategy that accounts for market turbulence by investing in multiple types of assets. This approach helps spread risk and can lead to smoother returns.

Investing in multiple asset classes is key to diversification. By investing across a broad number of stocks and multiple asset classes, you can blend different currents to give you a smoother journey.

Target date funds, like BlackRock LifePath, automatically diversify your investments based on how close you are to retirement. This means you can pick the fund closest to your target retirement date and let it do the rest.

As you get closer to retirement, the mix in your target date fund moves toward bonds, seeking to reduce risk. This is because bonds tend to keep to their own current and may be strong when the stock market is weak.

Remember, diversification is just a word for "don't put all your eggs in one basket."

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Monitoring your investments is crucial, even if you're using target date funds. These funds are often considered a set-it-and-forget-it option, but that's not always the case.

After a big life change, such as early retirement, it's essential to reassess your financial plans. This could involve adjusting your investment strategy, including whether to continue using target date funds.

Target date funds can be a great option for those with less complicated financial lives. However, for those who break the mold, it's helpful to meet with a financial advisor to evaluate your financial plan and make adjustments as needed.

There are three main investment approaches taken by target date funds: active, passive, and hybrid or blend.

Active portfolio management teams try to outperform broad market indexes by selecting actively managed investments.

Passive portfolio management teams, on the other hand, select passively managed investments designed to achieve performance that is aligned with an index, like the S&P 500 or Russell 2000.

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A hybrid or blend portfolio management team uses a combination of active and passive management, investing in actively managed investments when they believe it makes sense and using passively managed investments in areas where they believe active management may not add much value.

Here are the three investment approaches in a nutshell: