Saving for retirement and investing for retirement are two very different things. The savings part is easy enough. Take a portion of your income every year and set it aside for when you retire. It’s the investing that can be tricky. Target date funds were created as an easy way to invest for retirement.
We all know it can’t be that simple. The idea of eliminating the hassle of picking and choosing investments with a one stop shop retirement fund sounds good. It’s probably one of many options in your retirement account. But is it for everyone?
What Is A Target Date Fund?
Target date funds go by many names including age based funds, life cycle funds and target retirement funds. They are all built around the same premise. It’s a mutual fund built around an asset allocation based on a specific time frame or target date (usually a retirement date).
The target date mutual fund usually consists of a bundle of stock and bond funds based on its asset strategy. The fund is designed so the asset mix becomes more conservative the closer it gets to the target date.
How Does It Work?
You’ll need to know at least one thing in advance. Specifically, exactly when you want to retire. Not an easy decision for a 20, 30, or even 40 something to make. But is necessary when picking the right target date.
The idea is easy enough. If it’s 2012 and you plan on retiring in 38 years, you pick a 2050 target date fund. It’s that simple. The fund does the rest of the work for you. Any asset allocation changes and rebalancing is done automatically.
There’s A Fee For That
No matter how you bundle a group of index or mutual funds, there are going to be fees. Companies don’t do this for free. The fact that expense ratios have dropped so low and are still falling, shows just how lucrative mutual funds, index funds and now ETFs have been over the years. And the fund companies charge a fee for this fund bundling service.
The lower the fee the better. The target date mutual fund has a fee. Since it’s just a basket of other funds, it might be wise to dig into the costs of each fund it holds too. We’ll never eliminate the fees entirely, we can only hope to contain them.
Not For Everyone
A one size fits all solution to investing for retirement seems a bit too easy. There certainly are concerns. One being the idea of choosing an asset allocation strategy for the next several decades without being able to predict the future. There’s just too many unanswered questions and not enough leeway.
Target date funds won’t guarantee you a better opportunity to make money than if you picked out a basket of index funds and managed it yourself. It’s not much different from any other do-it-yourself project. If you’re comfortable and confident enough you can do-it-yourself and at a lower cost, you’re probably better off.
There’s something to be said about choosing your own investments. The learning experience alone is worth it, in my opinion. But it also allows you the ability to change direction when needed. Despite that, target date funds have a place for the right investors.