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Investing for your retirement can be stressful. If you want to do it well, there are all sorts of important things for you to learn about different types of funds, stocks, and bonds. You’ll also want to know how to diversify your portfolio by industry and balance your investments with the proper amount of risk depending on your age. This could turn into a full-time job!
That’s why there are a number of ways that the financial services industry tries to make it easier for you. One of those ways is via roboadvisers that balance your portfolio for you using algorithms, but another way that’s less often talked about or hyped is via target date retirement funds.
What Are Target Date Retirement Funds?
These are a particular type of mutual fund that focuses on making high quality diversified investments and which adjusts the risk automatically for you as you near your retirement date. By putting your money in a fund aimed at workers with similar projected retirement years, you don’t need to change funds as you age and want to invest more conservatively.
These types of funds are available in 401(k)s, IRAs, and taxable investment accounts. Generally, target date retirement funds are mutual funds composed of other different types of mutual funds to ensure diversification.
Target date retirement funds allow you to just choose one retirement fund rather than choosing individual mutual funds and setting up contributions for each. That convenience makes them very attractive to investors. As of 2013, MorningStar found that there was $500 billion in target date retirement funds in the US. Casey, Quirk, and Associates believes that by 2020 there will be over $7.7 trillion in U,S, target date retirement funds.
Advantages of Target Date Retirement Funds
There are a number of advantages to target date retirement funds. One of the biggest is that they take care of diversification for you. They provide you with exposure to different classes of investments, different industries and both U.S. and international stock and bond markets. Basically, a target date retirement fund does all of the diversification work for you.
Another great benefit of target date retirement funds is that they’re incredibly easy. All you have to do is choose one fund and that’s it. This reduces the amount of time that you have to spend thinking about your investments and managing them.
Target date retirement funds also come out ahead when it comes to rebalancing your investments. You don’t have to manually rebalance your investments by choosing different funds as you get older or if your investments in one industry do better than another. Essentially, target date retirement funds are the ‘set it and forget it’ way to save for retirement.
Finally, many target date retirement funds are also quite cost-effective. By reducing your management costs, you can maximize your investment returns over time.
Disadvantages of Target Date Retirement Funds
While target date retirement funds have some great features that are beneficial to your retirement, they also have many downside. The first is that, while they are generally cost effective, there are some that have high expenses so it is important to read the fine print to know exactly what they’re charging you.
Another downside is that with target date retirement funds you don’t have control over what kinds of investments you make. For example, if you don’t want to invest in tobacco, you might not be able to find a target date retirement fund that explicitly avoids those types of investments. Also, if you want to do socially responsible investing and seek out investment vehicles that are doing good in the world, such as investing apps, you also will not have that option with target date retirement funds.
In addition, these funds do not take personal situations into accounts. They do not know your goals around your retirement or other life milestones like if you want to send your kids to college or buy a home. You might also find they invest more conservatively or aggressively than you would if you were in control of your own investments.
Finally, one of the downsides of targeted date retirement funds are that they do not allow you to implement some of the strategies that could minimize your taxes in a taxable investment account. Since many people save with target date retirement funds in non-tax accounts, that might not be that big of a deal.
The Bottom Line
Target date retirement funds are a great option for people who don’t want to spend a lot of time worrying about their retirement savings, but want to make sure that they are rebalancing their portfolios and changing their risk tolerance as they age. While people give up greater individuation and control over their investments, they benefit from the automation of target date retirement funds.
Author: Jeff Gitlen