What is a Target-Date Fund
A target-date fund is a fund offered by an investment company that seeks to grow assets over a specified period of time for a targeted goal. Target-date funds are usually named by the year in which the investor plans to begin utilizing the assets. The funds are structured to address a capital need at some date in the future, such as retirement. The asset allocation of a target-date fund is therefore a function of the specified timeframe available to meet the targeted investment objective. A target-date fund’s risk tolerance become more conservative as it approaches its objective target date.
BREAKING DOWN Target-Date Fund
Target-date funds are an investment product derived from traditional portfolio management theory. They offer investors an investment vehicle that is professionally managed using an asset allocation strategy that takes into consideration risk tolerance over time.
Target-Date Fund Construction
Target-date funds are managed with a specific utilization date. They are typically used for retirement but essentially they can be used by an investor for any type of need requiring a specific utilization date.
Target-date funds are managed to a specified target date and therefore are considered to be long-term investments. As a long-term investment, portfolio managers have a predetermined time horizon for which they base their investment strategy on. Portfolio managers use traditional asset allocation theory guided by risk tolerance and liquidity. In July 2017, Vanguard launched its Target Retirement 2065 products. Given that the funds have a targeted utilization date of 2065, that gives them a time horizon of 48 years.
Target-date fund managers use the remaining investment horizon to determine a fund’s risk tolerance. Following the initial launch, a target-date fund has a high tolerance for risk and therefore is more heavily weighted toward high performing riskier assets. Target-date portfolio managers typically reconstitute portfolio risk levels annually. At the annual reconstitution, portfolio managers will reset the allocation of investment categories. Higher risk portfolio investments typically include domestic and global equities. Lower risk portions of a target-date portfolio typically include fixed income investments such as bonds and cash equivalents.
Target-date funds will also manage funds to a specified asset allocation through the target date. Most fund marketing materials show the glide path of allocation across the entire investment time horizon and through the specified target date. In the years beyond the target date, allocations are more heavily weighted towards low risk fixed income investments.
Investing in Target-Date Funds
Target-date funds are popular with 401(k) plan investors. Instead of having to choose a number of investments to create a portfolio that will help them reach their retirement goals, investors simply choose a single fund designed to help them reach that goal. For example, a younger worker hoping to retire in 2065 would choose a target-date 2065 fund, while an older worker hoping to retire in 2025 would choose a target-date 2025 fund.
Vanguard is one investment manager offering a comprehensive series of target-date funds. Below we compare the characteristics of the Vanguard 2065 fund to the characteristics of the Vanguard 2025 fund.
Vanguard Target Retirement 2065 Fund (VLXVX)
The Vanguard Target Retirement 2065 Fund has an expense ratio of 0.16%. As of October 31, 2017, the portfolio allocation was 89.86% stocks, 9.95% bonds and 0.19% short-term reserves. The Fund uses index funds as the underlying securities for investment. As of October 2017, the Fund had 53.90% of its assets invested in the Vanguard Total Stock Market Index Fund Investor Shares, 36.10% invested in the Vanguard Total International Stock Index Fund Investor Shares, 7.00% invested in the Vanguard Total Bond Market II Index Fund Investor Shares, and 3.00% invested in the Vanguard Total International Bond Index Fund Investor Shares.
Vanguard Target Retirement 2025 Fund (VTTVX)
The Vanguard Target Retirement 2025 Fund has an expense ratio of 0.14%. As of October 31, 2017, the portfolio allocation was 63.92% in stocks, 36.07% in bonds and 0.01% in short-term reserves. As of October 2017, the Fund had 38.40% invested in the Vanguard Total Stock Market Index Fund Investor Shares, 25.50% invested in the Vanguard Total International Stock Index Fund Investor Shares, 25.50% invested in the Vanguard Total Bond Market II Index Fund Investor Shares, and 10.60% invested in the Vanguard Total International Bond Index Fund Investor Shares.
The 2065 Fund is more heavily weighted toward stocks, with a relatively smaller percentage of bonds and cash equivalents. The 2025 Fund has greater weight in fixed income and fewer stocks so it is less volatile and more likely to contain the assets the investor needs to begin making withdrawals in 2025. In the years beyond the target date, both Vanguard target-date funds report an asset allocation mix of approximately 20% in U.S. equities, 10% in international equities, 40% in U.S. bonds, 10% in international bonds, and approximately 20% in short-term TIPS.
Proponents of target-date funds cite the convenience to investors of putting their investing activities on autopilot in one fund. However, with multiple target-date funds in the market, investors should be aware of their options. Investment companies and managers offer a variety of target-date funds with varying asset allocation strategies and underlying investments. With the variety of options, investors have an array of choices available to fit their risk and management preferences.