Target-date funds: What they are and how they work

What is a target-date fund?

A target-date fund is a mutual fund (or exchange-traded fund) that gradually rebalances and reallocates assets as you get closer to retirement, typically shifting the majority of assets from riskier investments such as stocks to more conservative – or fixed-income – investments such as bonds and cash. The fund is designed as a one-stop investment shop with a diversified set of asset classes. Target-date funds are gaining in popularity: At the end of 2020, they held $2.8 trillion of assets, according to Morningstar.

How target-date funds work

Target-date funds aim to alleviate the continuing task of a successful investment strategy: rebalancing and optimizing asset allocations. Some studies have shown that up to 90 percent of an investor’s return depends on how money is divided between various asset classes, from equities such as domestic and global stocks, to fixed-income investments such as bonds and cash. Target-date funds offer investors the convenience of automatically allocating assets in the fund from day one.

Consider, for example, a 2060 target date fund, which is geared toward investors who plan to retire by 2060. Early in the fund’s timeline, assets are geared toward higher-risk, higher-reward assets such as stocks. As the fund gets closer to its target year, risk is dialed back with a more conservative portfolio of fixed-income investments.

This aggressive-to-conservative switch doesn’t happen overnight. Instead, a target-date fund operates on a glide path. Think about an airplane descending on final approach to land. A target-date fund’s glide path employs a similar rationale – easing the investor to a safe financial destination at retirement.

Advantages of target-date funds

You can put your investing activities on autopilot

A target-date fund eliminates the need to constantly monitor and adjust your portfolio and reduces the stress associated with financial planning by the time you get to retirement. The fund has a defined trajectory when allocating assets in the portfolio.

You can make adjustments if necessary

If your time horizon changes, you can switch to a more applicable fund. If you determine that you are going to work for an additional five years, you can move your money into the 2065 target-date fund.

Disadvantages of target-date funds

Fund expenses can add up

Saving for retirement requires spending some money. Target-date funds all have expense ratios, and it’s important to compare these before selecting one for your money. You may notice that some target date funds carry higher fees than the index funds within them. Keep these expenses as low as possible to maximize your potential earnings.

No earnings are guaranteed

Target-date funds are investments, and all investments have the potential to lose value. It’s a simple reality of saving for retirement: You need to accept some degree of risk when investing for retirement.

Are target-date funds a good investment?

A target-date fund can be a smart and simple way to spread your money across investments that match your age and retirement goal needs. But not all funds of the same target date are created equal. For example, one 2060 fund from a provider may be more aggressive with more money in stocks than another 2060 fund from a different provider. To determine if the target-date fund is a good investment for your needs, read the fund’s prospectus and review the current portfolio breakdown and fee structure.

Keep in mind that the target date represents the beginning of another chapter in your life. The fund sets you up for retirement, but you will also need a plan for putting your money to work after you leave the workforce. After the fund reaches its target date, it shifts to a retirement fund. At that point, consider keeping some of the money in the fund while allocating some cash toward other investments to earn regular income from your savings.

The post Target-date funds: What they are and how they work appeared first on Bankrate

Original source: Bankrate

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