Target Date Funds: Pros & Cons [Video]
by Rob Stoll, CFP®, CFA Financial Advisor & Chief Financial Officer / December 15, 2020
Target date funds are a popular way to invest money these days. You usually find these funds within your company’s 401(k) plan or maybe your children’s 529 college savings plans. They are often called something like “target date 2040.” The year is tied to the timeframe of your goal.
Pros of Target Date Funds
Now the great thing about target date funds is that they really do take a lot of the guesswork out for you. When you’re young and saving for retirement you want to be more heavily invested in stocks and less in bonds so your investments can grow. But as you near retirement you want to make sure you’re not overly invested in stocks so the money is there when you need it.
Target date funds automatically adjust for the change in risk you desire as you get older. So say you are 30 years old today, you might own a target date fund that owns 90% in stocks. As you get closer to retirement it’s going to gradually reduce the amount of stocks that are in your fund. And what are they going to do with that money? They are going to take that money and put it in more conservative bonds. So they do that for you automatically. You do not have to think about it as you make retirement contributions. You do not have to rebalance your portfolio or anything. They take a lot of the guesswork out.
Now the one issue we have with target date funds is that as you near retirement they can actually make you invest more conservatively than you need to. So if you think about a typical retirement these days you might be retired for 25 or even 30 years. That’s a long, long time. Because inflation clips away at 3% a year we want to make sure your money is growing through that even during retirement.
Target date funds make life a lot easier for many people. If you are in what I call the growth stage (20’s, 30’s, and 40’s) and your retirement is still 20 plus years away, target date funds can be a great option for you. Just pick the date, let’s say target date 2050, around the time you expect you might retire. Then you can invest in that and set it and forget it for many years.
One Specific Issue of Target Date Funds
If you are nearing retirement, say within 10 years of when you think you are going to retire, it’s really important to consider investing it by choosing specific funds. One of the popular examples I like to use is the thrift savings plan with the federal government. By the time you hit age 65 you will be invested heavily in government bonds, which currently yield less than one percent. That kind of allocation is not sufficient for lasting 25-30 years in retirement. So if you own target date funds and you are starting to near retirement, within the next 10 years, you want to take a more cautious approach. We suggest you talk to someone about coming up with the right asset allocation for your life stage.
If you need any help with this or are nearing retirement we are here to help you plan your investments so that you can be confident in your future.
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Rob has over 20 years of experience in the financial services industry. Prior to joining Financial Design Studio in Deer Park, he spent nearly 20 years as an investment analyst serving large institutional clients, such as pension funds and endowments. He had also started his own financial planning firm in Barrington which was eventually merged into FDS.