Target date funds are mutual funds and ETFs which adjust their investment allocations between stocks, bonds, money market and other assets based on the fund’s stated target date. They have received a ton of negative press recently which we feel is due to a misunderstanding of how these funds work and who they are designed for.
Investors choose funds with target dates that are close to the year they plan to retire. Target date funds tend to have many different types of assets in the funds, including US Stocks, International Stocks, US bonds & money-market type investments. The secret sauce of target date funds is how they allocate funds to each asset type.
Although the allocation process will differ depending on which target date fund you choose, they should all follow a similar pattern: as the fund moves closer to and eventually past its target date, its investments will become increasingly more conservative. For example, a fund with a target date of 2050 will likely have a much larger percentage of its portfolio in riskier assets like stocks, than the same type of fund with a 2020 target date. Below are two screenshots from Fidelity’s website showing how the asset allocation in their 2050 target date fund will look in the year 2020 vs. the year 2045.
Fidelity’s 2050 Target Date Fund Allocation in the Year 2020
Fidelity’s 2050 Target Date Fund Allocation in the Year 2040
The target date of the fund is not meant to be the end date of the fund (where all the money is paid out to investors) but rather the retirement year of the investor of the fund. In most target date funds the fund manager will continue to make changes to the allocations in the portfolio after the target date for several years before shifting into income generating investments only.
A dynamic mix of stocks and bonds which adjusts based on your age is likely going to be needed when saving for retirement, regardless of your specific situation. Target date funds are a good place to at least start your research, so you can get an idea of what “standard” allocations look like. If you don’t like what you see, then you can decide which parts of the “standard” you would like to tweak, and go about choosing normal mutual funds or other investments which better fit your situation.
As a general rule, the further you are away from retirement, the lower your income, and the smaller your portfolio, the more likely target date funds are to be a good option for you. The closer you are to retirement, the higher your income, and the larger your portfolio, the more likely you are going to benefit from a more personalized approach.
Here is a list of some of the more popular target date fund providers:
T. Rowe Price