If you’ve taken a look at your 401k or IRA investment choices recently you have probably seen something called a Target Date mutual fund. We are going to take a look at what these funds are and why you might want to consider them for your retirement accounts.
The popularity of these Target Date mutual funds has risen in recent years and they are available in almost all of your investment accounts. You will see them by different names depending on the mutual fund company who provides them: Schwab calls them Target Funds, Fidelity calls them Freedom Funds, Vanguard calls them Target Retirement funds, American Century calls them Livestrong Portfolios and in the Microsoft 401k plan they are called LifePath Funds. The names are different but the concept is the same.
The other thing you will notice is a year associated with them: 2020, 2030, 2040, etc. The year represents your target retirement date.
All of these funds follow an investment philosophy called asset allocation. Asset allocation is just a fancy term used to describe how the investments in your account are spread around. I wrote a blog post titled “Asset Allocation: What is it?” if you want to learn more about this strategy.
Asset allocation mutual funds have been around for years. The only difference is that with target date mutual funds the asset allocation percentages change over time. In the early years a higher percentage is allocated to stocks. As the fund approaches the target date it shifts and allocates more to bonds and cash.
This shift is what is referred to as the “glide path.” See the picture below to get an example how the percentages change over time.
An Example of a Target Fund Glide Path.
The reason the allocation percentages change over time is that as you approach retirement you want to become more conservative. As you near retirement you want less exposure to stocks which tend to be more volatile than bonds and cash.
You may want to consider them for your retirement accounts if you don’t have the time, knowledge or desire to select your own mutual funds. Instead of having to select multiple funds to fulfill you asset allocation strategy, you simply select one fund that is closest to your estimated retirement date.
Inside this one fund it will distribute your money to the various types of investments and it will automatically shift to be more conservative as you approach your retirement date. It is a simple way to make sure you are not putting all your eggs in one basket (or put another way: it is a simple way to make sure you are well diversified).
If you do an internet search on these target date funds you will encounter some negative news like: high fees, poor performance, you can’t tailor the asset allocation to your personal circumstances and the list goes on. Keep in mind that many of these arguments can also apply to your other mutual fund choices as well, they are not unique to target date funds. In addition, if you want to target a specific allocation for yourself you can just select a different target date. An earlier date will have less exposure to stocks (i.e. more conservative) and a later date will have more exposure to stocks (i.e. more aggressive).
I like to make things simple for my clients because I feel the simpler I can make things, the more likely you are to commit to positive changes in your financial life. Take a look at these target date mutual funds because they truly are the simplest way to invest without having to go through the difficult process of selecting your own mutual funds. “One and done” as I like to say.
