U.S. Markets open in 2 hrs 5 mins

What is an ETF? — Part 14: Target-Date Funds

tlydon@globaltrend.com (Tom Lydon)

Exchange traded funds continue to increase in number and popularity, growing to one of the most commonly traded securities on the stock exchange as both institutional and the average retail investor gain greater access to broad or specialized market exposure. Yet many individuals are unfamiliar with ETFs’ inner workings. In this ongoing series, we hope to address your questions and help shed light on the investment vehicle. [What is an ETF? — Part 13: True Liquidity]

Investors seeking to stash away a nest egg for their golden years do not have to meticulously pick out individual assets and securities to build a customized retirement portfolio from the ground up. Instead, investors may opt for the simplified approach through a target-date ETF.

Target-date, age-based or life-cycle ETFs are a type of hybrid fund that automatically reallocates a bag of stocks, bonds or cash equivalents in its portfolio based on a predescribed time horizon. Accordingly, fund providers offer various target dates with varying time horizons – the Deutsche Bank db-X line of target date funds come in 10-year increments and the iShares suite come in five-year increments.

These investments try to provide a once in a lifetime decision for investors. Target-date ETFs with a longer time frame will act more aggressive and gradually shift toward a more conservative approach as the shareholder ages.

For instance, the iShares S&P Target Date 2015 Index Fund ETF (TZE - News) has a heavier weighting in domestic fixed-income assets at 46.6%, followed by a 35.9% weighting in domestic equities and 16.3% in international equities. In comparison, the iShares S&P Target Date 2050 Index Fund ETF (TZY - News) only has 7.6% in domestic fixed income, with the lions share of the weightings in domestic equity at 61.5% and international equity at 29.4%.

Investors should always consider the weightings of the funds before relying on them as different providers may have varying methodologies in constructing their products. For example, the DBX TDX Independence 2020 ETF (TDH - News) holds 43% in domestic equities, 13% in international equities and 44% in fixed income, whereas the iShares S&P Target Date 2020 Index Fund ETF (TZG - News) has 42.3% in domestic equities, 19.4% in international equities and 37.1% in domestic fixed income.

Potential investors who are also thinking about supplementing a target-date strategy with additional asset allocations into equities and bonds should also mind their overall portfolio weights. Furthermore, target-date funds do not guarantee perfect protection for future events. If the equities markets were to miraculously double in returns as the target-date ETF matures, the retiree may not realize the large gains since the fund will have a higher allocation in fixed-income. Similarly, the funds don’t protect investors if the markets suddenly tank before the target date is reached.

Nevertheless, the target-date ETFs provide a simple and easy way for investors to set aside some money for their retirement years.

For past stories in this series, visit our “What is an ETF?” category.

Max Chen contributed to this article.