A target date fund is a type of mutual fund that many people add to their retirement savings accounts in order to diversify their investments—“target date” usually refers to the date on which the portfolio owner wishes to retire. Using this type of fund can lead to more conservative investing once the target date has been reached. While this approach may appeal to those seeking a way to protect their retirement portfolio, it does have some disadvantages.
Risks of target date funds
Funds within funds: Allocation issues
Target date funds are not funds by themselves. They are funds within funds. This can pose a problem when you want to own a certain amount in assets because there are many classes of funds in which you’ll be investing.
Target date funds are blind investments—they don’t take into account your goals or anything else in your portfolio. These funds also do not consider the implications of your other investments, the goals you’re attempting to achieve, the risks associated with those goals, or other income you may have in retirement.
Without these considerations, it’s as if this investment stands alone, which can be quite risky.
Target date funds appeal to people looking for a low-cost investment option. While many of the funds have low minimum investment requirements, they come with high expense ratios instead. These expenses include fees to instate the mutual funds as well as fees to manage them.
The benefits of target date funds
Despite the aforementioned issues with target date funds, millions of people continue to add them to their retirement portfolios. That’s because the benefits are often enticing enough to overshadow the risks.
Low minimum investment
Investing in target date funds doesn’t take a lot of money. You can start investing in some funds for as little as a few hundred dollars. This is attractive to investors just starting out or those that just want to dip their feet into the world of target date funding conservatively.
Once you set up a target date fund, you can essentially forget about it. This appeals to many people who are not interested in becoming big investors but who want to start a little something in addition to their shaky 401(k).
Many believe that target date funds are designed to fit everyone’s portfolio. This makes them simple because there isn’t much research involved.
Will you invest?
When trying to decide whether to add target date funds to your investment portfolio, you should thoroughly research your available options. Analyze asset allocation, diversification, quality of underlying funds, available fund families, and expenses involved.
Once you’ve researched all of these aspects, you’ll start to clearly see which one or ones are best for your portfolio, and you will be able to proceed with confidence.
Jeff Rose is a Certified Financial Planner and Iraqi combat veteran. He blogs at Good Financial Cents, Soldier of Finance and Life Insurance By Jeff.