Target-date funds are the ultimate set-it-and-forget-it investment retirement strategies, but does that make them better for your plan?
A target-date fund allows an investor to set a date (retirement date is a popular choice) and the fund will downshift out of risk as the date gets closer. This can be great because it offers more protection from a market crash that may occur right before you are set to withdraw funds from the account.
Fidelity reported 401(k) accounts sank by an average of 19% in the first quarter of 2020 after the coronavirus outbreak triggered the fastest stock market crash in history. While the market has recovered a lot of those losses in a short amount of time, shocks like that are what target-date funds are designed to protect against.
Target-date funds are generally funds-of-funds, or essentially a basket of different funds, and your portfolio manager will reallocate money into less risky assets like bonds as the target date gets closer. After the fund date is reached, the account will generally be more heavily weighted in fixed-income and low-risk assets.
Pros and Cons of Target-Date Funds
Target-date funds are a great way to get some returns on your money if you don’t want to get too far into the weeds with your investing. There are so many ways to grow (or lose) money through different investment vehicles. These accounts allow you to set a date and then let the fund manager take over.
This is a great option if you have a set retirement date because you can just choose that date and the fund manager will do the rest.
Target-date funds also offer a lot of diversification, which means you will have less to worry about if a single asset within doesn’t perform as well over time. These types of investment vehicles generally cover a lot of different asset types as well.
There are downsides to target-date funds as well.
For one, you need to watch out for fees with this type of investment vehicle. Because these are funds made up of other funds, there can be some extra expenses required because each could have a fee on top of the one associated with what you are actually invested in.
It’s worth taking a second to look at your target-date fund in your 401(k) to see the fees involved. There may not be many (or any) at all.
You can also see what assets your target-date fund is allocated into. If it’s made up of a bunch of passively managed funds, it may be more beneficial to move that money straight into a low-cost index fund or other passive investment vehicle that doesn’t have a lot of fees attached.
While it’s convenient to pick a fund and forget about it, if you want to get more into investing this may not be the best option for you. You may have different goals in your life that require a more aggressive investing strategy, or you may just want to have more control over your investments as you learn more.
And remember, a target-date fund only sets a target — that doesn’t guarantee you’ll hit it. You may plan to retire in the year 2035, but what happens if you need to retire earlier? Being overly exposed to riskier assets after retiring while you wait for the fund to shift into a more conservative mix can mean losing more than expected if the market sinks.
Target-date funds are very common in 401(k) plans, and they offer many benefits for retirement savers looking for an easy way to invest in a diverse bundle of assets. Look at your own 401(k) and if it’s invested in a target-date fund, make sure it’s the right fit for your own life goals.