Free Annual Reports
Pick A Retirement Date: Target-Date Funds Will Do The Rest
If you are confused about the concept of properly allocating assets as you head for retirement, or simply do not want to be bothered by it then target-date funds might be for you. The concept is remarkably simple; all you need to do is project the year of your retirement, and choose the target-date fund accordingly. The managers hold a diversified portfolio and reallocate the funds as the target date draws near, slowly moving farther away from stocks toward income-driven bonds.
These funds, which are very similar to life-cycle funds, are touted as one-stop-shop investing, and leave the investor with nothing else to worry about. However, there are drawbacks to being so hands off. (For background reading on target-date funds, see Life-Cycle Funds: Can It Get Any Simpler? )
What's Your Target?
For investors who like the hands-off approach, target-date funds can be a valuable tool. The funds are presented by big names like Vanguard, T. Rowe Price, and Fidelity. Each fund family has a series of funds with target dates attached, usually in five-year intervals.
Let's say an investor is 34 years old and wants to retire at 65. This leaves 31 years to go, and a projected retirement in 2039. This investor would want to look at the Vanguard Target 2040 (VFORX) or the T. Rowe Price Retirement 2040 (TRRDX). It is really that simple; just project the retirement date and pick the best corresponding fund. All the rest of the work is completely taken out. I choose T. Rowe Price and Vanguard to showcase, because not all target-date funds are alike. These two fund families consistently get high marks from Morningstar. (To learn more, check out Picking The Right Mutual Fund.)
The Advantages of the One-Stop Shop
These funds solve two of the big investing problems; diversification and asset allocation. When investing for retirement it is very important to be smart about it. Your retirement savings are not a discretionary fund you can get reckless with, this is money that should be invested keeping in mind that it will need to sustain a certain quality of life.
Not paying attention to diversification could leave an investor susceptible to a volatile portfolio, and what if the portfolio is on a down swing when retirement hits? Target-date funds take care of this problem by continually holding a mix of domestic stocks, foreign stocks, bonds, and cash. The investor is completely diversified with just one mutual fund.
The other pitfall is asset allocation. Even an investor who diversifies can fall into this trap. Imagine a portfolio that is weighted 80% stocks and 20% bonds with 30 years to retirement. Now over time stocks traditionally outperform bonds, so over these 30 years the stocks are growing at a faster pace and with two years to retirement are now 95% of the portfolio. If a stock market downturn occurs in those last two years, then the whole portfolio is at risk. Not to mention that at retirement the portfolio should be more focused on income producing investments like bonds. Target-date funds fix this by continually adjusting the portfolio's weighting as the target date approaches moving more toward bonds and farther from stocks.
We can see how this works when we examine two of T. Rowe Price's funds: the 2040 fund currently has around 88% in stocks and 8% in bonds, meanwhile the 2010 (TRRAX) fund holds 59% in stocks and 34% in bonds. Bad asset allocation and diversification can be two of the biggest pitfalls for someone investing for retirement; target-date funds solve those problems.
The Pitfalls
These funds are great for the hands-off investor, but do have some dangers. The main problem is obviously that the investor loses control. Not everyone retiring in 2040 has the same risk tolerance. I am sure there are people retiring in two years who have no interest having 59% of their money in stocks, and there are others who want more. For those investors all they can do is add additional investments to the funds they would like. If you are picking your own investment allocations, then why even be in a target-date fund in the first place? These funds certainly have a client base, but for those actively interested in investing, these are not a good choice.
The other problem is that while it seems target dates all have a similar strategy, they are not all created equal. Vanguard and T. Rowe Price get the highest marks, according to morningstar.com. But investors should also look at the allocation over the life of the fund to see if it fits their needs. This can be projected pretty well by looking through the series or look at T. Rowe Price's 2010 (TRRAX), 2020 (TRRBX), 2030 (TRRCX), and 2040 (TRRDX) to see how the allocation changes over time. (For an in-depth discussion of the potential problems with these funds, see The Pros And Cons Of Life-Cycle Funds.)
The Bottom Line
The creation of target-date funds is great for people who do not wish to be bothered by their investments. Some funds are very good, and make it very simple for investors to get an appropriate portfolio set up for retirement, all in one fund. These advantages are great for investors who are not confident in their abilities to pick a group of investments. The pitfalls are that the investor loses control of the decision making process, and not everyone retiring in the same year has the same risk tolerance. Think hard about whether target dates suit you, if they do, make sure to do adequate research to find which fund family best fits your goals and risk tolerance.
These funds, which are very similar to life-cycle funds, are touted as one-stop-shop investing, and leave the investor with nothing else to worry about. However, there are drawbacks to being so hands off. (For background reading on target-date funds, see Life-Cycle Funds: Can It Get Any Simpler? )
What's Your Target?
For investors who like the hands-off approach, target-date funds can be a valuable tool. The funds are presented by big names like Vanguard, T. Rowe Price, and Fidelity. Each fund family has a series of funds with target dates attached, usually in five-year intervals.
Let's say an investor is 34 years old and wants to retire at 65. This leaves 31 years to go, and a projected retirement in 2039. This investor would want to look at the Vanguard Target 2040 (VFORX) or the T. Rowe Price Retirement 2040 (TRRDX). It is really that simple; just project the retirement date and pick the best corresponding fund. All the rest of the work is completely taken out. I choose T. Rowe Price and Vanguard to showcase, because not all target-date funds are alike. These two fund families consistently get high marks from Morningstar. (To learn more, check out Picking The Right Mutual Fund.)
The Advantages of the One-Stop Shop
These funds solve two of the big investing problems; diversification and asset allocation. When investing for retirement it is very important to be smart about it. Your retirement savings are not a discretionary fund you can get reckless with, this is money that should be invested keeping in mind that it will need to sustain a certain quality of life.
The other pitfall is asset allocation. Even an investor who diversifies can fall into this trap. Imagine a portfolio that is weighted 80% stocks and 20% bonds with 30 years to retirement. Now over time stocks traditionally outperform bonds, so over these 30 years the stocks are growing at a faster pace and with two years to retirement are now 95% of the portfolio. If a stock market downturn occurs in those last two years, then the whole portfolio is at risk. Not to mention that at retirement the portfolio should be more focused on income producing investments like bonds. Target-date funds fix this by continually adjusting the portfolio's weighting as the target date approaches moving more toward bonds and farther from stocks.
We can see how this works when we examine two of T. Rowe Price's funds: the 2040 fund currently has around 88% in stocks and 8% in bonds, meanwhile the 2010 (TRRAX) fund holds 59% in stocks and 34% in bonds. Bad asset allocation and diversification can be two of the biggest pitfalls for someone investing for retirement; target-date funds solve those problems.
The Pitfalls
These funds are great for the hands-off investor, but do have some dangers. The main problem is obviously that the investor loses control. Not everyone retiring in 2040 has the same risk tolerance. I am sure there are people retiring in two years who have no interest having 59% of their money in stocks, and there are others who want more. For those investors all they can do is add additional investments to the funds they would like. If you are picking your own investment allocations, then why even be in a target-date fund in the first place? These funds certainly have a client base, but for those actively interested in investing, these are not a good choice.
The other problem is that while it seems target dates all have a similar strategy, they are not all created equal. Vanguard and T. Rowe Price get the highest marks, according to morningstar.com. But investors should also look at the allocation over the life of the fund to see if it fits their needs. This can be projected pretty well by looking through the series or look at T. Rowe Price's 2010 (TRRAX), 2020 (TRRBX), 2030 (TRRCX), and 2040 (TRRDX) to see how the allocation changes over time. (For an in-depth discussion of the potential problems with these funds, see The Pros And Cons Of Life-Cycle Funds.)
The Bottom Line
The creation of target-date funds is great for people who do not wish to be bothered by their investments. Some funds are very good, and make it very simple for investors to get an appropriate portfolio set up for retirement, all in one fund. These advantages are great for investors who are not confident in their abilities to pick a group of investments. The pitfalls are that the investor loses control of the decision making process, and not everyone retiring in the same year has the same risk tolerance. Think hard about whether target dates suit you, if they do, make sure to do adequate research to find which fund family best fits your goals and risk tolerance.
Free Annual Reports
