It can be a struggle to find the proper financial instruments in preparing for retirement. There seems to be infinite options when choosing investments for 401ks and IRAs. To clear the noise, target date funds are appropriate investment tools to utilize when looking to grow assets in preparation for retirement.
Target date funds, also known as age-based funds, are a type of mutual fund; these funds are a basket of securities managed by professionals, for a fee. What target date funds allow an individual to do is invest their retirement savings in accordance to dates when they are expecting to retire, such as 2035 or 2045. The asset mixes of target date funds will shift in accordance to their target dates.
As target dates approach, the asset mixes of the target date funds become increasingly conservative. For example, let’s say a target date fund currently has an 80/20 allocation between stocks and bonds; this fund’s asset mix may change with an increased exposure to bonds and decreased exposure to stocks as time passes. Bonds are generally considered to be more conservative investments than stocks.
Similar asset mixes can be seen in target date funds with similar dates. When choosing the right target date fund, investors not only need to consider their retirement date but also fee structure of the fund. Target date funds charge fees to compensate the professionals managing the fund.
These fees, known as expense ratios, vary from fund to fund. For example, the three big providers of target date funds are Vanguard, Fidelity, and T. Rowe Price. Their respective expense ratios for their 2035 target date funds are 0.15%, 0.77% and 0.74%. Of the three, Vanguard provides the lowest fee which is important to keep in mind when an investor chooses a target date fund best for them.
It is also important to note that the asset allocation within target date funds should be considered when evaluating the entire asset allocation of a portfolio. For example, let’s say 80% of a $100,000 portfolio is in a target date fund and 20% of it is in stocks; the asset allocation of the target date fund is 70% stocks and 30% bonds. The entire portfolio is actually 76% ($76,000) in stocks, not just 20%, because of the target date fund’s allocation.
All in all, target date funds are a popular and simple financial tool to utilize in preparation for retirement. The professionals behind these funds adopt a long term outlook in managing its assets.
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