These financial tools automatically rebalance as you near retirement
A target date fund is an investment instrument designed to become more conservative as it approaches a predetermined future date. For investors looking to simplify their retirement strategies, target date funds can be appealing for their “set-it-and-forget-it” nature. But how do they work and are they the right tool for your retirement planning needs?
How a target date fund works
A target date fund is a fund that can hold a diversified basket of mutual funds and ETFs. The fund’s assets allocation automatically shifts over time until it reaches a preset target date, such as your expected retirement date.
Target date funds have a risk profile that changes over time. Typically, a target date fund will accept more risk—in exchange for higher potential return—early on. As the fund nears its target date, it will shift its assets to favor stability—mitigating the risk that the fund will lose value just when you’re ready to cash out.
In most cases, target date funds mature in years ending in 5 or 0. Retirement planning investors usually select a fund that matures close to their expected retirement date. A young person just starting their career might choose a fund that matures in 2065 or 2070. Someone preparing to retire in 10 years might opt for a 2030 or 2035 maturity date. If you wanted to dial in your risk tolerance, you could even buy into two funds with different target dates. For example, if you were retiring in 2057, you could buy into a 2055 target date fund and a 2060 target date fund.
Understanding the glide path
A glide path is the formula that determines how assets within a fund will be allocated over the life of the target date fund. Glide paths are divided into two categories: “to” and “through.” For a fund with a “to” glide path, the fund’s asset allocation adjusts until the retirement date arrives, after which the mix of assets held in the fund remains fixed. A “through” glide path, on the other hand, will continue to adjust its holdings through your retirement date and afterward.
Depending on the specific fund, the glide path may be steep, or it may be more gradual. A gradual glide path might begin decreasing investment in riskier equities by 1% per year after the investor turns 50 and reallocating those funds into a more secure asset class, such as bonds, until the target date arrives. A steeper glide path strategy might increase the percentage of change over a shorter period. Your financial advisor can help you choose a target date fund with a glide path best suited to your financial goals and risk tolerance.
Using target date funds beyond retirement planning
While it is common for target date funds to be earmarked for retirement, they can be used to pursue other financial goals as well.For instance, you may wish to set up a target date fund to save for your child’s college expenses by investing in a fund that will mature as they approach graduation day.
Many investors use target date funds to simplify investment decisions. Choosing a target date fund puts your investment strategy on autopilot—once you set it in motion, the fund will follow its glide path until it matures.
Historically, target date funds have tended to be more expensive than other investment vehicles because the investor is responsible for both the fees of the fund and its underlying funds. While such fees have decreased in recent years, it’s important to understand a target date fund’s expense ratio and how it compares to other options before choosing it.
However, the convenience of target date funds makes them quite popular. Investors who seek more variety, on the other hand, may prefer to diversify their retirement investments to include other funds with differing amounts of risk and return.
Whether you’re saving for your retirement, college, or another long-term financial goal, consult your financial advisor to help determine whether a target date fund fits into your investment plan.
Information provided by Valorem Financial and written by Oechsli a non-affiliate of Cetera Advisor Networks, LLC and CWM, LLC.