To the layperson, investors are usually seen as a knowledgeable and busy bunch. They’re not wrong. The best investors are active, managing their portfolios regularly and making small improvements as they go along.
But investing can be for everyone – not just stock market gurus and Wall Street fanatics. So how can more casual investors put their money towards good use without spending all of their time as well as finances?
That’s where target date funds come in handy. Designed for the hands-off investor, they’re a great way to invest your money without investing your time.
What are Target Date Funds?
Target date funds are a basket of funds designed for investors who want an easy retirement option. Like their name, these funds are organized by date. Investors can choose which fund they want based on the corresponding year in which they hope to retire.
For example, a 25 year-old may choose a 2055 target-date fund, when they’ll be 65 years old.
So how exactly do the funds change over time? Like with most investment strategies, it’s all about intelligently handling market risk.
As the investor gets older, the fund automatically rebalances to become more conservative over time. The fund that a 25 year-old purchases will be allocated towards safer investments when that consumer is 40, and even safer when they’re 60.
Many investors who want to save for retirement are unable, uninterested or uncertain of their ability to choose their own funds. Creating a solid mix of funds can require hours of research, and staying on top of their allocation can be a chore even for the most seasoned financial professional. That’s why target-date funds are so popular; they already have the funds and investment strategy chosen for you.
Target Date Fund Fees
One of the downsides to a target-date fund is its fees.
Fees have decreased in recent years, but investors still need to check that their returns are not being overtaken by outrageous charges. Fees are required to be listed so investors can easily compare various funds, so don’t be afraid to read the fine print.
The difference between a fund with fees between 0.49% to 0.76% and one with 0.16% and 0.18% could be $38,000 for someone who invested $5,000 a year for 30 years.
How to Manage Your Target-Date Fund
Too many people choose a target-date fund based on inappropriate considerations. Instead of choosing it based on the date you hope to retire by, consider your tolerance for risk. Some people may be more tolerant and need to invest more aggressively, while others are more conservative. Don’t assume that you have to stick with the date that works for your age.
Even though the fund rebalances on its own, investors still need to check how it’s doing. Not all target-date funds are created equal, and each company’s target-date fund is allocated differently and provides different returns.
Between Fidelity, Vanguard and T.Rowe Price’s 2020 target date funds, the returns range from 5.5%, 6.58% and 7.15% respectively. You have to examine each fund individually, not as a package deal.
Target date funds are perfect for people who make irrational decisions – the funds are designed to allocate based on past returns and current strategy. Investing is a patient man’s game, and TDFs can encourage investors to adopt the strategy of the tortoise instead of the hare.
Because TDFs can be used as a “set it and forget it” investment option, they’re ideal for those who get nervous about every slight swing in the market. Target date funds are perfect for people who want to be investing, but don’t want to have to worry about what they’re investing in.
You can choose a target-date fund for your 401k or IRA – they’re perfect for either.