In Blog, Wealth Management

Saving for retirement is crucial for securing your long-term financial stability and ensuring independence in your later years. But, for the average person, understanding all of the different investment platforms, tools, strategies, and advice can feel overwhelming. Developing thorough financial literacy takes years, and people typically don’t have time to conduct the research needed to invest confidently. This lack of confidence has understandably caused many to underfund their retirement savings, with an estimated 75% of Americans not meeting retirement savings targets.

In this article, we’ll review why target date funds are one type of investment option that can help you simplify your retirement planning approach and help you reduce risk through proactive management from a trusted partner.

What is a Target Date Fund?

A target date fund is an investment fund (mutual fund or ETF) that is intentionally diversified and managed to realize the best performance by a specific date (e.g., the date of retirement). The assets comprising a target date fund vary and include a mixture of high and low risk investments that are re-balanced and re-allocated over time. While the fund might initially start with a more aggressive mixture of investments that could even include speculative stocks, it will eventually transfer to less volatile investments like bonds and cash equivalents.

How Do Target Date Funds Work?

Target date funds employ a “sliding” risk scale that becomes more conservative over time. The evolving combination of asset classes is designed to help the average investor manage risk and optimize their 401(k) as retirement approaches. In addition to retirement planning, target date funds can also be used for other types of investment priorities that are set aside to help with anticipated expenses, such as higher education. No matter how they’re being used, target date funds all rely on the same principle of graduated risk reduction as the fund nears the target date.

Advantages of a Target Date Fund

Simplified Investment Approach

Target date funds are a simpler, less hands-on approach to retirement investing. Rather than scouting, selecting, and monitoring multiple investments, you can focus your retirement savings on a single fund that is optimized to achieve the results you need at the time of retirement.

Active Management

Financial experts know how to calibrate investment risk tolerance based on the target fund date. Because the portfolio is actively managed, the mixture of asset classes is continually adjusted to maintain healthy performance. This means that you don’t have to spend time pouring over financial news and manually adjusting your investments.

Risk Reduction Near Retirement

Market volatility always presents risks to retirement accounts and other types of investments. Large economic swings can dramatically impact the value of your investments. With a target date fund, your investments are diversified from the time your portfolio is created. Portfolio diversity can be advantageous for mitigating market movements as your retirement arrives. The last thing anyone wants to see is a significant drop in the value of their portfolio as they prepare to retire.

Disadvantages of a Target Date Fund

No investment approach is entirely foolproof, and each method of saving for retirement has pros and cons. The primary caution regarding target date funds is to closely examine and understand the fee structure. Remember that target date funds significantly simplify and streamline your investment portfolio, and you continually benefit from expert management until you begin to withdraw from the retirement account. The higher fees associated with target date funds offset the time and expertise required for effective management by your financial partner.

Also, depending on how they are set up, some target date funds will need to be changed once you are ready to begin withdrawing for your retirement. A qualified financial advisor can help you understand exactly how this process works.

How to Determine if a Target Date Fund is Right for You

Target date funds are a great option for those that want a single strategy and approach to retirement savings. While target date funds can consolidate and clarify your investment tactics, there are a few considerations to keep in mind.

First, a target date fund works very well if you are planning to keep your money in a retirement account until you’re eligible to withdraw the funds. Realizing the benefits of a target date fund requires you to understand and accept that there will be fluctuations in performance, particularly during the early years of your investing.

You must also be willing to consistently save for your retirement. While target date funds often require low minimums to start, all retirement strategies rely on the participant to reliably set aside contributions for continued growth.

If you want to learn more about how a target date fund can help you reach your retirement goals, schedule a consultation with me and we’ll review your priorities, goals, and questions together.

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