What are target date mutual funds?
Target date mutual funds simplify the investment process, and for many investors, these funds can be an effective way to achieve diversification with only one investment product. Typically, investors have encountered these funds on their company’s retirement plan, and the product name usually aligns with their retirement age goal.
For example, one may see XYZ 2035 Fund and, by strategy, this fund is aimed at employees and investors aiming to retire around 2035.
The goal of these target date funds is to transition from aggressive to more conservative as the fund nears the target date. This means increasing bond exposure and decreasing equity exposure. And to be fair, the simplicity in the fund’s name can be an effective call to action towards investing for retirement.
Composition of Target Date Mutual Funds
To better understand target date funds, one must also understand the composition of these funds. These funds typically are funds of funds under one financial institution, which means they utilize multiple mutual funds in one product to achieve an overall domestic equity, international equity, and fixed income allocation. Since these funds are diverse, it is difficult to compare their performance to one benchmark. A blended benchmark is more appropriate in this circumstance. Morningstar, S&P 500, and Dow Jones all have relative target date benchmarks that may be appropriate to judge performance of your underlying target date fund.
Disadvantage of Target Date Mutual Funds
The strengths of target date funds have been highlighted above. However, there are some weaknesses in these strategies, primarily articulated in that we believe every investor has unique goals and objectives. To lump all investors in the same allocation who will all hopefully all reach retirement at the same time may not be optimal. We believe it is necessary to examine risk tolerance, overall household income, and net worth to peg the optimal allocation for a given investor.
A well-crafted allocation should be understandably simple, and this is why target date funds are effective. But it may be to your advantage to consult with a Registered Independent Advisor (RIA), who can be an effective resource in actively managing a retirement plan that is easy to understand, and a plan that is right for you as you transition to retirement.