Target-date funds have made investing easier over the past few decades, offering investors a one-stop investment solution. Also known as life-cycle or age-based funds, they comprise of a mix of holdings that alter over time, based upon a specific target date.
Such funds have allowed many individuals to gain confidence in investing beyond cash and CDs. This is a positive step forward, and there are certainly merits to using target-date funds in a number of situations. However, there are also indicators that a savvy investor should be cognizant of in advance.
When Are Target-Based Funds a Good Idea?
Saving For College With Age-Based Funds
Most 529 college saving plans offer age-based investment options that gradually shift a child’s college investments from an aggressive allocation when they’re young to a more conservative allocation as they approach age 18.
Saving for college is very different from saving for retirement, as the period over which your child will deplete the account(s) is typically finite and short-lived. We therefore recommend utilizing target-date funds since they gradually move towards an ultra-conservative posture as college withdrawals draw near. (For related reading, see: Using Time Horizons in Investing.)
Young Investors Getting Started
If you’re just getting started and aren’t yet ready to delve into an ongoing engagement with an advisor who’s qualified to guide your investment and financial planning decisions, then target-date funds are a great launching point. They help you to save and invest for your long-term future. Just be aware of how you use these funds if you have other nearer-term goals, such as saving for a house (see more below).
Small Balances In Retirement Accounts
If you’re new to a job or just starting to contribute to a retirement plan, a target-date fund might be the best solution as it keeps things simple for small balances.
When Are Target-Based Funds Risky?
You Have A Shorter-Term Goal
A critical time when target-date funds can be risky is when you have short-term objectives like buying a new home or a car. If you choose a fund based upon your projected retirement date or age, you could be subjecting your savings to more risk than you can afford across the full continuum of your finances, particularly shorter-term needs. (For related reading, see: Best Strategy for Short-Term Savings Goals.)
Your Assets Have Grown
As your assets accumulate and your planning needs become more complex, target-date funds often become rudimentary relative to your financial circumstances. Your growing wealth needs more sophisticated investment and planning stewardship, including services that more critically evaluate your complete financial picture in terms of:
- Tax planning opportunities
- Benefits of municipal bonds
- Risk management
- Retirement planning
A target-date fund assumes that you’re an average American. It has no comprehension of your true financial situation, needs or objectives. It doesn’t take into account any pension benefits, when you should start Social Security, how much savings you have for retirement relative to your needs, or an array of other life events like buying or selling a home, caring for an aging parent, a second marriage, illness or other. Whether you use target-date funds or not, always be sure that your assets are properly structured for you. (For related reading, see: Why You Should Be Wary of Target-Date Funds.)
Target-Date Funds After Retirement
While target-date funds help many Americans create an easy investing path toward retirement, they’re less than ideal once you actually retire. Most funds quickly shift to a conservative posture, with heavy bond allocations. Shifting to cash and bonds helps to mitigate risk, but it might not align with your overall investment objectives nor with your growth needs to sustain retirement income over your lifetime.
If you do elect to utilize target-date funds in retirement, be aware that whenever you withdraw money, you’ll have to sell shares of both stocks and bonds. This might not be wise in varying market cycles. We typically prefer to utilize bonds to cover withdrawals during market downturns, allowing stocks to recover, rather than locking in losses. This choice won’t be available to you from a target-date or asset allocation fund.
Beware of Target-Date and Asset Allocation Fund Fees
Target-date funds are often structured with a fund-of-funds approach, which layers on additional fees. Fees are often close to 1%, but can sometimes be well above that, occasionally reaching 2%. It pays to evaluate your fees to determine if hiring an advisor would offer a lower cost structure, coupled with customized and comprehensive investment and financial planning services. (For related reading, see: Pay Attention to Your Fund's Expense Ratio.)
If you’re not sure that target-date funds are well suited for you, consider consulting with an independent, fee-only certified financial planner for advice. Ask about investment options, fee structures and a combination of investment and planning services allowing you to devise an investment strategy based upon your unique personal finances and future financial and life objectives.
(For more from this author, see: Is Maxing out Your 401(k) Contribution Enough?)
The information contained herein is obtained from sources believed to be reliable, but its accuracy or completeness is not guaranteed. This article is for informational purposes only. The views expressed are those of SageVest Wealth Management and should not be construed as investment advice. All expressions of opinions are subject to change and past performance is no guarantee of future results. SageVest Wealth Management does not render legal, tax, or accounting services. Accordingly, you, your attorneys and your accountants are ultimately responsible for determining the legal, tax and accounting consequences of any suggestions offered herein.
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