The pros and cons of target-date funds
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When reviewing your company retirement plan’s investment options, you’ve probably seen the list scattered with funds with a date in the title. These are called target date funds—sometimes called “lifecycle” or “age-based” funds. So, what are target date funds? And should you invest in one?
What is a Target-Date Fund?
A target-date fund is composed primarily of a combination of pre-selected stock and bond mutual funds. Each target-date fund is associated with a date that corresponds to when the owner will use the funds. Most people select a fund with a target date that reflects their anticipated retirement year. The fund is designed to become more conservative and take on less risk the closer it gets to the “target date.”
The Positives of Target-Date Funds
Here are some reasons you might find target-date funds an attractive addition to your portfolio:
- Simple. Target-date funds can be helpful for investors who may not be as financially sophisticated or want to take a hands-off approach to their portfolio. The fund manager(s) changes the allocation systematically and rebalances as necessary over time without the investor worrying about it.
- Diversified. Target-date funds are diversified to reflect their time horizon among stock (domestic and international) and bonds and industry representation. This relieves the investor of making any allocation decisions.
There’s Always a Downside
While target-date funds are convenient and require little, if any, management on your part, don’t sign up yet! You also need to consider their limitations:
- Lack Customization Capabilities. Target-date funds lack customization, as they give fund managers full discretion without considering personal financial situations or changes in risk tolerance, such as income changes, early retirement, or loss of a spouse, which may impact long-term goals and risk tolerance.
- Fees Can Be Substantial. Usually the fees on target-date funds are higher than other types of mutual funds offered in a retirement plan. This is because they pass on the fees from the underlying investments that make up the fund, along with adding their own management fee. Morningstar reports that the average target-date fund’s annual fee is more than 1 percent.
- Target-date Funds Can Differ. Not all target date funds follow the same model. Some are “through,” and some are “to,” meaning some invest through the target date and continue to become increasingly more conservative years after the fund’s target date. Others invest to the target date and then stop taking risk within the fund, assuming you’ll manage the risk from then on. This difference will impact your allocation over the entire time period. However, both become more conservative over time.
Summary
Whether or not you invest in a target date fund will most likely depend on how much control you want over your overall allocation. If you do choose to use one, familiarize yourself with the specifics of the fund to ensure it fits with your overall investment plan.
Austin Stagman is a Portfolio Manager at Bedel Financial Consulting, Inc., a wealth management firm located in Indianapolis. For more information, visit their website at www.BedelFinancial.com or email Austin at AStagman@BedelFinancial.com