What is a target date fund and when should you invest in one?

Target-Date Funds are a retirement planning option that takes two headaches out of the way for investors: choosing a mix of assets and realigning those investments over time.

This type of fund – also known as a life cycle fund or retirement fund – aims to continually strike the right balance between the risk required to build wealth and safe bets to protect a growing nest egg. The fund automatically balances your portfolio with the right mix of stocks, bonds and money market accounts as you age.

What are target funds?

At the beginning of your working life, a target-date fund is generally geared for growth by having a much larger proportion of your portfolio in stocks rather than fixed income investments like bonds, which are safer but offer lower returns. As your retirement year approaches, the fund will gradually shift to more bonds, money market accounts, and other lower-risk investments.

These are mutual funds buy from other mutual funds (known in the industry as “funds of funds”) to build a diversified portfolio. As you set and forget, the fund will update your asset allocation over the years.

Your retirement year is the “target date” for most of these funds, and the funds are conveniently named to match your planned retirement year. For example, let’s say you are 40 years old and plan to work until you turn 65, which would be in 2045. Most funds with target dates are named in five year increments.

Best cut-off date funds with low costs for winter 2021

Here are some popular target date funds designed for investors looking to retire in 2045, sorted by 5 year annual return. We have selected funds open to new investors with low cost (no sales commissions and expense ratios of 1% or less) and minimum investments of $ 2,500 or less.

American Funds 2045 Carries Retirement Date R5

TIAA-CREF Life Cycle Index 2045 Premier

Fidelity Freedom Index 2045 investor

T. Rowe Price retires in 2045

Vanguard Target Retirement 2045 Inv

Data as of September 3rd, 2020.

Why invest in target funds

The main attraction of target funds lies in their simplicity. “When you think about putting funds together as if you were cooking a good meal, asset allocation is your ingredient choice,” said Laura Scharr-Bykowsky, director of Ascend Financial Planning, LLC, a financial planning firm in Columbia, South Carolina. For funds with a target date “it’s an instant meal – they’ve put all the ingredients together for you.”

Convenience is a big reason many Americans already have target-date funds.

Your convenience is a big reason many Americans already have Targeted Funds, although many may not know it. Target Date Funds are the standard plan of choice for many employer-supported retirement plan providers such as 401 (k) accounts. At the end of 2014, according to the Investment Company Institute, around half of all participants in the 401 (k) plan had invested at least part of their liquid funds in target funds, and the trend is rising.

Another benefit of Targeted Funds is that they discourage investors from being their own worst enemy by reacting too much to market turns, which often results in them buying at high prices and selling at low prices.

“In 2008, most 401 (k) owners stuck to their plan, while in the parallel world of do-it-yourself investors, emotion prevailed and they withdrew,” said financial advisor Jonathan Broadbent, founding partner at Plan Partner in Beachwood, Ohio . Those who got out undermined their ability to benefit from the long post-crisis bull market, Broadbent says.


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This is how target funds work

Targeted funds can be a quick approach to portfolio management, but recipes and ingredients can vary widely in your menu of offerings.

A characteristic of all target-date funds is their “glide path,” or how the funds descend from a high proportion of riskier equity funds to safer investments like bonds and then land to freeze your asset allocation at its most conservative mix to get your nest egg.

For example, a fund can start with a strong mix of domestic and global equity funds that make up 90% of the total investment. In retirement, however, equity funds make up only 30% of total investment, while fixed income investments like bonds and short-term funds make up the rest. Providers offer a more sophisticated range of strategies and blends to arrive at your final asset allocation.

An important question to ask yourself when choosing funds with a target date: is this a “to” fund where the glide path freezes your asset allocation in the year you want to retire, or a “through” -Fund holding the glide path for 10. continues years or more after retirement before freezing your asset allocation? The “through” fund philosophy is that life (hopefully) doesn’t end when you retire. You may still have 20 years or more of the cost of living, and the glide-path to safer investing should reflect that.

Various funds with a cut-off date can extend the glide path 10, 15 or 20 years after retirement. So choose a fund that suits your retirement goals.

How to invest in target funds

There are three ways to invest in a target fund. As mentioned above, Target Date Funds are a common preset choice for a 401 (k). If you have a 401 (k) and have never changed the contents, there’s a good chance you already have a target-date fund.

You can also open a brokerage account with a fund manager or online broker to buy funds with target dates. Or you can buy a fund direct from a fund provider like Vanguard, Fidelity, or T. Rowe Price, but your options there may be more limited.

The Fund may require a minimum initial investment which can range from $ 500 to $ 3,000 or more. However, some funds forego the minimum investment when you make monthly deposits into your account.

Other important things to note:

How much does it cost? In addition to the initial deposit, take into account the ongoing fees that you will have to pay. The cost of a mutual fund is called its Expense ratio, an annual fee expressed as a percentage of your investment – or, as the name suggests, the ratio of your investment to the fund’s expenses. The higher the fees, the more costs can detract from the overall return.

According to the Investment Company Institute, the average key date fund had an expense ratio of 0.51% in 2016. But these fees can range from as little as 0.1% to more than 1.5%, so there is room to shop. The price difference often revolves around whether the fund relies on cheaper passive investment strategies or more expensive actively managed accounts.

Know what’s inside. Don’t just compare spending, compare the funds’ investment philosophies as well. Understand that two identical 2050 funds can have very different strategies for reducing your investments from a heavier mix of stocks to bonds as you age. The asset allocation strategy can be too conservative – or not conservative enough – depending on your risk tolerance. (This is also a good reason to open up your 401 (k) and see if there are other target funds on offer that are a better fit than the standard selection.)

It is better not to “forget” it completely. While the fixing nature of target-date funds is an important characteristic, experts recommend reviewing your fund’s performance once a year to make sure it continues to work for you. Also, check out other investments that you hold. How do these assets and your target fund fit together? If you don’t know, you run the risk of collapsing asset classes twice and even buying the same fund twice, experts warn. An annual review of your entire portfolio could identify such problems.

Remember, the growing popularity of target-date funds doesn’t mean they are foolproof: all investments come with risk, and target-date funds are no exception. But for many investors, convenience from a single source makes target funds the right choice.

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