Just before the financial crash of 2008, one type of fund getting a lot of press was the targeted retirement fund. The idea cooled a bit during the recession, but the idea of these funds is starting to pick up in popularity again. While targeted retirement funds aren't for everyone, some investors find that they take a lot of the worry out of retirement planning, and provide peace of mind. Before you take the plunge, though, it helps to carefully consider your options.
First Things First: How Does A Targeted Retirement Fund Work?
The idea behind a targeted retirement fund is that all of the asset allocation stuff you would have to take care of on your own is done for you. Targeted retirement funds usually come with dates. If you want to retire in 2040, you would pick a fund with that target. You would invest a set amount of money in your fund each month, and, at first, the investments in the fund (which might even be investments in index funds) are more aggressive.
However, as you approach your target retirement date, the asset allocation shifts. Instead of investing heavily in stock funds, for example, the retirement fund might begin to shift toward investing in bond funds. The idea is that, as you near your retirement date, you should have a more conservative asset allocation, protecting you, to some degree from market crashes too near your retirement date. It you are into “set it and forget it”, a targeted retirement fund can be a boon.
And, of course, you can hold a targeted retirement fund in a tax advantaged retirement account. Hold your fund in an IRA or a 401k, and you will enjoy the tax benefits associated with your account, whether it is a Roth or a Traditional account.
Choosing A Targeted Retirement Fund
Before you decide on a fund, though, you have to do your research. Just because you don't want to mess with your retirement fund down the road doesn't mean you shouldn't do your due diligence now. Research your options. Morningstar provides information on a number of targeted retirement funds. Look for funds that:
- Have low expenses. If the targeted fund invests in funds, then you want to watch out. The underlying funds will have expenses, and the targeted fund itself will add another layer of expense. Even so, it is possible to find a targeted retirement fund with low fees.
- Offer the diversity you are looking for. Check into the underlying investments to see that you are properly diversified.
- Provide the risk mix you want. In some cases, you might find that a fund is too aggressive, or too conservative, for your tastes. Look for a fund that is likely to fit with your idea of acceptable risk at various points during the target period.
A targeted retirement fund isn't for everyone. However, for someone who wants his or her retirement fund set on automatic, it can be a good idea to check into these funds. If you like index funds, you can choose a targeted fund that invests in index funds. There are also funds that include individual stocks, bonds and other investments. Figure out the kind of asset mix you want, and choose a fund that offers it — and that will re-balance in a way that you approve of as your retirement date draws near.
Great article! I’ve been doing some research into target retirement funds and there are a lot of compelling reasons to invest and not to invest in one. I more than likely will not be going into one because I would like more control over the composition of my portfolio.
-Ravi Gupta
Target date mutual funds sound attractive, and have lured investors who want to put their retirement plan on automatic, but the reality is they are generally a poor investment vehicle.
Most of these funds, even the shorter target dates, lost 25-40% of their net asset value in the 2008-9 bear market. A fixed asset allocation, even if it does change as it moves closer to the target date, still subjects investors to heavy losses in bear markets. Losing 40% of your investment is devastating to a portfolio regardless of what your age is. A tactical asset allocation strategy allows investors to become more conservative when prices are high and more aggressive when prices are low (http://arborinvestmentplanner.com/tactical-asset-allocation-strategy.php )
Thank you.
Ken Faulkenberry
Not all funds are created equal. You should always ask for the debt to equity ratio, leverage ration because this mutual fund is where you pay someone to do the thinking for you, you might fall into the trap of thinking they’re all the same. They’re not.
Thanks for the reassurance. My 401K is through Fidelity, so I use their most aggressive target fund, but I like having it all set on automatic.