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Target Date Funds: Investing for Retirement on Autopilot

You may have a target-date fund and not even know it.

In fact:

If you have an employer-sponsored retirement plan (such as a 401(k) plan), you're probably already investing in a target-date fund.

So what are target-date funds, you may be wondering -- and does it matter if you have no idea what the term means?

Well, it at least kind of matters.

You can probably get through life just fine without knowing what a target-date fund is, but we would argue that it’s better that you know and understand them than not.

So let’s get to it and drill down.

What Are Target Date Funds?

A target-date fund is designed as a single mutual fund made of a diversified number of mutual funds with an asset allocation that slowly changes as you reach your target retirement year.

They’re often sometimes abbreviated as TDFs, and sometimes you’ll hear target-date funds called life cycle funds or birthday funds.

While we’re at it, you’ll see target-date funds spelled as target date funds and target-date funds, without the hyphen. There seems to be no universal standard for how to spell it.

But, the main thing to remember is that there’s a target date for the fund.

So if you plan to retire in 2055, then 2055 is your target date.

How Target-Date Funds Work

As noted, these are mutual funds with a target date, or an end date to the investments.

Example: A 2055 target-date fund

So let’s say that the target date is the aforementioned January 1, 2055.

Because 2055 is quite awhile off, your investments – likely some sort of combination of stocks, bonds and cash – will be riskier and bold in the early years, when you can afford to lose some money if things don’t go well, and they will, over time, become more conservative and safe, the closer you get to 2055.

Because obviously in 2052, you don’t want to lose a big chunk of your wealth and feel like your retirement is now in jeopardy.

But you also don’t want to play it safe during all of the years you’re investing.

For instance, an interest-bearing savings account is one of the safest investments there is – but the reason people tend to not throw all of their money into one and retire on the interest is because the interest is extremely low (compared to potential stock market returns).

If you invest without any risk, chances are, you aren’t going to earn much at all.

Target-date funds is a popular retirement strategy, in part because you can kind of “set it and forget it.” The fund automatically changes over the years, slowly shifting from riskier investments to safer ones.

"To" or "Through" the Target Date

If you have a target-date fund (and this is one reason why understanding them is important), you’ll want to know if you the target-date is considered to go “to” 2055 or “through” 2055.

Some target-date funds are, as noted, going to be as conservative and safe as it gets the moment that January 1, 2055 date arrives.

But a target-date fund that is listed as going “through” 2055 means that it won’t be completely 100 percent safe and conservative on January 1, 2055.

The mutual fund may still be flexing its muscle and making investments that could lose value.

Some target-date funds work that way because if you plan on retiring in 2055, you probably hope to stick around and enjoy your retirement money.

It isn’t as if you’re going to say, “Well, I’m retired, and now I’m not interested in making any more money. I want to make nothing else.” You might be excited, eager and very interested to have your investments still growing.

On the other hand:

You may feel like, “Sure, it would be nice to make some more money, but what if there’s a major recession and another pandemic in the year 2054? I want my investments to have no chance of lowering. I do not want to take any financial risks once it’s the year 2055.” If that’s the case, you want a target-fund date that goes “to” a certain year and not “through” a certain year.

If your target-fund date goes through and not to 2055, it may still somewhat aggressively make investments for another 10, 15 or 20 more years past your retirement date. You can select how much longer you want it on that “still investing” path, which everybody calls the “glide path.”

If you’re not sure whether the target-fund date is going “to” a year or “through” it, take a look at the fund’s prospectus – basically, the equivalent of the fund’s owner’s manual. It’ll be in there.

What You Should Know About Target-Date Funds

Your target date will be in the name of the fund.

So if you want to retire in 2055, don’t pick a target date with the number 2030 or 2070 in it.

Not all funds are the same.

That is, just because you’re picking a target-date fund with 2055 in it, it doesn’t mean it’s exactly like the other target-date funds that have 2055 in it.

So if you're looking at Fidelity's target-date fund, it will probably allocate investments differently than T. Rowe Price. So you want to do some comparison shopping before investing in a target-date fund.

You’ll need some money to start the target-date fund with.

Your fund may ask for $500 or $1,000 or even $3,000 or more.

That said, if you’re able to make monthly deposits to your account, you may be able to get that minimum initial deposit waived and go with, say, $100.

Target-date funds often are spaced out five years apart.

Not always, but you will have more luck finding a target fund date that ends in 2050 or 2055 or 2045 than, say, the year 2051.

The history of target-date funds.

In case you’re curious, they’ve only been around since the 1990s. The Pension Protection Act of 2006, however, was the year that they started to become popular with the public.

Just because you have a target-date fund, doesn’t mean you’ll have enough to retire.

That’s probably and hopefully obvious, but it all depends not only on how your investments do, but how much you’re investing throughout the years.

You’ll have something when it’s all over, but when that target date arrives, depending on what you’ve put into it, you might have enough to retire on for seven months or 30 years.

Tips

Set up a 401(k)

If a target-date fund sounds good to you, and you don’t have a 401(k), you may want to look into setting one up. Many 401(k)’s are, from the get-go, set up with a target-date fund.

Open a brokerage account

You can open up a target-date fund at an online brokerage or with a fund manager.

Buy one directly from a fund provider

Vanguard, Fidelity and T. Rowe Price are some popular ones.

Be sure to comparison shop

We said this earlier, but it bears repeating.

Not all target-date funds are the same.

Some target-date funds invest in individual stocks and bonds; others just focus on funds, such as an equity mutual fund, index fund or a money market fund.

And if you look through the prospectus and study the TDF’s investment strategy, you’ll get a better sense of its risk strategy and whether it’s in line with your own thinking.

Pros

Some pluses of target-date funds:

It’s easy

Once you start the target-date fund, you don’t have to do a thing.

You aren’t the one managing the money

Your portfolio will be professionally managed. That is, you don’t need to sweat the details – and if you’re worried you wouldn’t manage your investments well, you can stop worrying about that.

Plenty of diversification

Your money will be spread out over a lot of different types of investments, maybe more so than you would pick if you were doing this on your own.

Cons

But there are some negatives…

Maybe it’s too easy

The genius of a target-date fund is that you “set it and forget it,” but what if you aren’t getting as much out of the TDF as you thought.

You should pay some attention to your retirement portfolio.

Don’t be, like, 25 years old, start a target-date fund, and then not think about it until you’re 70. Take a look at how you’re doing every once in a while.

You may need to put more into the target-date fund to ensure you have enough to retire on, or you may want to change how you’re investing for your retirement.

Fees

Some target-date funds may have higher fees (usually called expense ratios) than you’d be comfortable with, if you were paying attention to them.

The fees tend to be around .01 percent, on the low side, to as high as 1.5 percent, (they’re a percentage of whatever your annual investment is).

Maybe not enough diversification

As we’ve noted, not all target-date funds are alike and equal, and so you want to shop around and really get a feel for the fund – rather than just grabbing the first one you see and think, “Sounds good.”

Bottom Line

Target-date funds can be a good or even great strategy for investors who want to invest but don’t feel equipped to handle the details themselves, year after year.

If you have a financial advisor, obviously you’ll want to discuss whether target-date funds are something you’ll want to invest in.

If your employer has enrolled you in a 401(k), take a look at it and see if it’s a target-date fund – and whether that’s the retirement strategy you want to take.

But one thing is for sure – while target-date funds may or may not be the best thing ever, and while you may want to try something else, target-date funds are far better than not investing at all.