Are Target Date Funds Good or Not?
Why Target-Date Funds Might Not Be For You
Contributing columnist, Alexandra Deluise
Target-date funds are one of many popular retirement fund solutions that are worth considering as you plan your future. However, as with all retirement options, target-date funds should be approached with caution and a healthy dash of education. By understanding what target-date funds are, as well as the pros and cons of investing in such a fund, you might find that target-date funds aren’t a good fit for your investing style and retirement goals.
As with most investments there’s no perfect answer to the question, “Are target date funds good or not?” Read on to find out if target date funds are good or bad-for you.
What are Target-Date Funds?
Target-date funds are investment plans with a specific end date in mind. In the case of retirement, a target-date fund would be set with an end date that corresponds to your retirement goals. A 30-year-old in 2015 with a retirement goal of age 65 would set a target date of 2050, for instance.
The handy thing about target-date funds is that they automatically change your asset allocations to an appropriate combination of stocks, bonds, and other investments based on how far in the future the target date is. Of course, as with all investments, there are risks: you are not guaranteed growth on your investments, and your asset values will fluctuate. However, these target-date funds are designed to give you the best chance at having the necessary growth to meet your retirement goals.
The Benefits of Target-Date Funds
One of the benefits target-date funds offers is simplicity. Instead of needing to decide on a balance of investments, the fund balances your investments for you. These funds are designed to lean towards more risky or aggressive asset allocations for target dates that are farther in the future, when time is on your side to make up any losses due to market fluctuations. As you get older and closer to the target date, the funds’ allocations scale down risk to make it less likely (although not impossible) that large losses will take place.
Because target-date funds recalibrate their investments, or the percentages in stock funds versus bond funds, as time goes on, many people can take comfort knowing that their level of risk will decrease and that their funds will, eventually, be reallocated. This prevents stagnant investments, and also allows less confident investors to take comfort in the knowledge that they have little to do in the way of decision-making.
This can also keep nervous investors from making bad investment choices due to their anxiety over the ups and downs of financial markets.
The Downsides of Target-Date Funds-Are Target Date Funds Good or Not?
Unfortunately, target-date funds do not offer much room for individualism. The one-size approach may not work with your investing preferences. Target date funds don’t account for each person’s needs, level of comfort with risk, and goals. These funds may not consider investments that you feel intuitively or through research may pay off; likewise, these funds may automatically allocate some of your money toward investments you would prefer not to select.
Target-date funds may also offer the illusion that they are a hands-off investment, when in reality a careful eye is still required to get the most out of your chosen fund. While the fund is set up to maximize your chances of hitting your goals by the chosen date, you should still be prepared to be involved in your investment choices.
So, are target date funds good or not?
Why a Target-Date Fund Might Not Be For You
It is important to consider target-date funds from many angles before deciding whether one is the right choice for your retirement needs. While there are some appealing benefits to these funds, here are four negative sides to target-date funds that you need to keep in mind as you consider them:
1. There is still risk involved in target-date funds. As with any investment, your assets can fluctuate in either direction. The history of any one fund cannot accurately predict its future. There is no guarantee of growth even as you approach your target date and the investments become less risky. Asking yourself whether or not you are willing to work with the risks involved in these funds is an important key step.
2. There is little active management of target-date funds. Although in general, there’s some consensus that when considering the excess fees, active management may not lead to better returns, some investors prefer active managers. Additionally, there is a group of investors who like to try their hand at stock-picking.Bonus Content-Learn to create your own mutual fund, without the management hassle.
The asset mixes change every 4-5 years on average, which gives investments a long time to crash and burn. Additionally, because these funds require so little maintenance, fund managers may not diversify investments enough for you to benefit fully from the market. Other opportunities may provide you with more active fund managers who will diversify and change your investments as the market changes. You may also want exposure to certain asset classes which aren’t included in your particular target date fund.
3. Target-date funds are not personalized, so your own investing aggressiveness is not considered. Although a target-date fund may place a 30-year-old in risky investments, it is possible that this individual is happier with conservative investments. Likewise, while a target-date fund for a 55-year-old nearing retirement is likely to be more conservative, that specific individual might prefer to take on more aggressive investment options to increase the potential return on his investments.
4. The cost of target-date funds also needs to be considered, as the transaction fees can be 1% or more. While a 1% transaction fee may not seem like much at first, these fees add up over the lifetime of your fund, potentially equaling thousands of dollars. Looking for investment opportunities that don’t charge “load” fees or high transaction fees may be in your best interest, especially when the other potential downfalls of target-date funds are considered.
As with any investment decision, think and research to figure out whether target date funds good or bad for you, personally. Taking on a target-date fund is not a decision to be made lightly or without performing your own due diligence or consulting an investing professional. Your own investing style needs to be considered in connection with your retirement needs and the goals you have for your investments. By educating yourself on target-date funds and your alternatives, you can make an informed and potentially lucrative decision about how to best fund your retirement.
Finally, it’s up to you to determine whether target date funds are good or not.
Staff columnist Alexandra DeLuise combines her banking experience with real-world financial advice to provide simple money tips to everyday people.