There are seemingly endless investment vehicles out there for your money.
You could invest in individual stocks, mutual funds, exchange traded funds, bonds, real estate, cryptocurrency, and more.
I could have kept that list going, but you get the point.
While the variety of choices sounds good, in many ways it has the opposite effect.
Many individual investors are left scratching their heads wondering which one is best for them.
As a result, many fall prey to analysis paralysis and end up not investing at all.
But there is a solution, and it is target date funds.
This investment is a one-size-fits-all solution that lets you invest at once and forget about it until your retirement!
I know it sounds too good to be true, but in this post, I am going to walk you through target date funds and how they might be the thing that finally gets you to start investing your money so you can reach your financial goals.
Should You Invest In Target Date Funds?
What Are Target Date Funds?
The target date funds are an investment solution that automatically shifts the direction of your investment from high-returns, high-risk to low-returns and low-risk as you move closer to your retirement date.
To put this another way, you can think of target date funds like an airline pilot turning on the autopilot feature.
He plugs in the destination and other information and then he can sit back and monitor things as the autopilot does the work flying the plane.
As an investor, you plug in your retirement day and then sit back and monitor things as the investment grows over time.
The main goal of target date funds is to rebalance your money as you approach retirement age to more conservative investments, so less of your money is at risk.
They do this by moving money from stock investments over to bond investments.
By investing in these funds, you grow your wealth when you are young and can take on more risk.
As you age, your portfolio shifts to a more conservative strategy, which limits risk, therefore protecting the wealth you have built.
Understand that these investments go by a few different names.
So if you come across terms like lifecycle funds, age-based funds, target retirement funds, target risk funds, or dynamic-risk funds, know that they are essentially the same thing, just different packaging.
How Do Target Date Funds Work
I briefly touched on this above, but want to go into more detail about how they work specifically.
The reason people invest in the stock market is for the return.
There are very few places where you can earn a decent return on your money safely.
And you need the higher return of the stock market as opposed to your savings account if you want to reach your retirement savings goals.
For example, let’s say you determine you need $2 million dollars for retirement.
You are currently 30 years old and want to retire at age 65.
By investing in the stock market and earning 8% annually, you need to save close to $11,000 every year to reach your goal.
Alternatively, if you put your money into a savings account that earns 0.50% annually, you need to save around $54,000 every year to reach your goal.
As you can see, investing in the stock market is important of you want a chance to reach your financial goals.
But as you age, you don’t want to put the money you’ve earn at risk.
You want to keep it safe.
With an age based fund, it will shift the investments away from riskier stocks and into safer fixed income holdings as you age.
This is the main idea behind the target date funds.
To put this into a real life example, a 24 year old school teacher who is planning to retire at 65 might consider investing in a 2060 target date fund.
The term target date signifies the approximate date she plans to start withdrawing her money.
Understand that most fund families offer target date funds in 5 year increments.
So you will see a 2025 fund, a 2030 fund, a 2035 fund, etc. If your retirement year happens to fall in between these 5 year windows, you can choose either fund that is closest to your retirement goal.
Coming back to the example, as the teacher ages, her investment is slowly changing to a more fixed income based asset allocation to preserve the wealth she has built.
This change doesn’t happen overnight, it slowly happens over time.
Finally, if you are uncomfortable investing yourself, you there are fund managers out there that will custom build these investments for you.
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In the case of a managed fund, your portfolio manager will manage your investment using a tool known as “glidepath” for balancing the mixed investment options to make your target date fund.
You can think of a glide path as a roadmap.
It helps in determining the tolerance for risk in your investment over your entire career phase.
It is a powerful tool that keeps guiding your investments over time and protects your money from potential risks.
Of course, you do not need to invest with a professional fund manager to invest in target date funds.
You can do it yourself just as easily.
What Makes Up A Target Date Fund?
All target dates funds are a fund of funds.
What this means is that they are made up of other mutual funds from a single fund family.
For example, a Fidelity target date fund will be made up of other Fidelity mutual funds.
The nice thing about this is you can invest in a single target date fund and have exposure to many areas of the stock market.
You will be fully diversified and there is no need to seek out other investment options.
What Are The Fees?
Target date funds charge expense ratios just like your ordinary mutual fund.
The average expense ratio for these funds is 0.51%, which is higher than investing in passive index funds.
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But you can find target date funds with lover expenses from names like Vanguard and Fidelity.
You just have to do a little digging to find the most cost effective one for your needs.
Should You Invest In Target Date Funds?
Target date funds make it easier for average investors who are looking to save for their retirement in order to maximize their income after retirement.
Also, if you own a 401k plan, chances are you are already investing in a target date fund because most plans use them as a default investment option.
The answer to whether or not you should invest in a target date fund depends entirely on your retirement goals.
Depending on that, there are several investment strategies you can select at the time of getting involved with target date funds.
Understand that you are not required to invest in a fund that is close to your retirement date.
Going back to the teacher example above, if the teacher is more risk averse, meaning she doesn’t want to take on a lot of risk, she could invest in the target 2050 fund instead.
Doing this will put more of her money into fix income holdings, reducing the chance of her losing a lot money if the stock market falls.
Of course, she could do the opposite as well.
If she wants to take on more risk, she could invest in the target 2080 fund.
This will put more money into equities, allowing for more growth.
Understand that there are trade offs to both situations.
Investing more conservatively throughout your career and you run the risk of your money not growing enough to meet your needs in retirement.
Investing more aggressively towards the end of your career and you run the risk of losing a lot of money if the market crashes.
This could force you to delay retirement.
Target date funds are a good investment strategy for people who are overwhelmed by the many investment choices out there.
You just have to make sure you understand all the benefits and drawbacks before you invest.
The last thing you want to do is invest your money in a way that puts your retirement plans at risk.