Maintaining a proper asset allocation is a common struggle for many Americans trying to build a comfortable retirement nest egg. Rising in popularity, target-date (or life-cycle) funds reduces the workload when managing a constantly changing portfolio.
At the end of 2010, there were 7,581 active mutual funds in the United States, according to the Investment Company Institute. The overwhelming number of mutual fund choices plays a role in confusing and misdirecting people who strive to make sound decisions in establishing their nest egg. Furthermore, long-term individual investors are advised to stick to asset allocation to keep their risk in check.
Fortunately, target-date retirement funds makes the job much easier.
Diversified For Safety
Proper asset allocation is a regularly preached investing principle that uses calculated diversification to find the right balance between risk and reward. It teaches you to not put all your eggs in one basket.
The general strategy is to be more aggressive at a young age (by having more assets in stock than bonds) and more conservative at retirement (by having more assets in bonds and cash than stocks).
You don’t want to be 65 years old and lose most of your retirement savings when the stock market crashes — as it did to many retirees in 2008-2009.
A popular rule of thumb is to have a percentage of assets in stocks that is equivalent to 120 minus your age. When you are 30 years old, you would have 90% of your portfolio in stocks and 10% in bonds. At 60, you’d have 60% in stocks and 40% in bonds.
Even after you have set up your portfolio with a target asset allocation, remember that movement in the prices of stocks and bonds will disrupt those percentages.
This is where target-date retirement funds to help re-balance your portfolio to the desired asset allocation.
Your One-Stop Retirement Tool
Target-date, or life cycle, funds are made up of multiple mutual funds that track broad market indexes.
Big name investment companies that offer such funds include Vanguard, Fidelity, Charles Schwab, TIAA-CREF, and T. Rowe Price.
All you have to do is pick the year in which you expect to retire. If you are 30 now and expect to leave the workplace at 65, you could choose to contribute to a 2045 or 2050 target-date fund.
The fund will re-balance when the percentages of stocks and bonds deviate from their targets. Additionally, the asset allocation will automatically change as you get older.
If you prefer to focus on contributions, don’t want to deal with managing the asset allocation, and tend to forget to re-balance the portfolio, consider a target-date fund for your all-in-one retirement solution.
Also, it doesn’t hurt that the expense ratios for these funds are usually much lower than that of actively managed mutual funds.