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What is a Target-Date Fund?
A target-date fund is a mutual fund that invests in stocks and bonds. The fund is designed to adjusts its mix of assets to more conservative investments as the target date gets closer. The target date is the date an investor will need the money from the fund. Target-date funds are often recommended when planning for retirement.
These funds offer a convenient way for an investor to accumulate retirement assets without having to manage the investments themselves. An investor simply chooses a target-date fund that is closest to when the invested money will be needed. This is often the date the investor plans to retire. The fund asset mix will be set based on the length of time to the target. A fund with a long time horizon will be more heavily invested in stocks. Over time the fund will continue to adjust to a more conservative allocation of investments. These are usually bonds.
The main advantage to a target-date fund is that the fund adjusts to a more conservative mix without the investor having to do the work. This is convenient for anyone who is not interested in investing. It is also convenient for anyone who feels too overwhelmed to manage their own investments.
A target-date fund is a fund of funds. This means that the one mutual fund is invested in a group of underlying funds. The underlying funds are invested in the stocks and bonds. For example, a target-date fund may have several underlying index funds within it. It may have a total U.S. Stock fund, an international fund, and a bond fund. The percentage invested in each underlying fund will change as the fund moves toward the target date.
One problem with these funds is that they do not fit each individuals unique needs. Risk tolerance and an investor's other assets are not taken into account. Plus, many funds still have a high percentage of stocks even within five years of the target date. This can cause a lot of portfolio loss without a lot of time to regain from the losses.
Another disadvantage is that many times the underlying funds are actively managed. This raises the costs of the fund thereby taking more money away from being invested. Also, some of the funds may invest in more riskier assets than an investor would be comfortable with on his/her own.
What can an investor do? The best option is to do a little research before choosing a target-date fund. One thing to look for is the fund cost. A low-cost fund will leave more money to invest. An investor can compare funds from different companies. Some companies keep stock exposure much lower close to retirement than their competitors. The portfolio turnover and list of underlying funds is another area to compare. A low turnover is better. It is better if a fund invests in just a few basic underlying funds such as the total stock market and total bond market. Unfortunately, many target-date funds offered in 401ks are invested in a lot of underlying active funds. An alternative would be to skip the target-date and go with a few basic index funds with low costs.
Another option is to go with a shorter horizon in a target-date fund. The target-dates are a guide so choosing one five years earlier is fine. This will reduce the stock exposure for someone more risk averse. Finally, a target-date fund can be used in an investor's younger years and then switched to a fund with less stock exposure close to retirement.
Target-date funds are designed to be a convenient option for investors. They can be beneficial with careful research. A low-cost, index-based fund that adjusts to a conservative mix close to retirement seems the best option.
May I recommend my ebook, Investing $10K in 2013
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