Target date mutual funds – also known as age-based funds or life-cycle funds – are low maintenance, retirement plan products that operate under as asset allocation formula, which adjusts itself as it gets closer to the year you will retire.
You may be familiar with the concept if your employer pension plan participates in one of these funds.
Choosing a fund
Target date mutual funds are designed to be the only investment vehicle that an investor uses to save for retirement so the asset allocation isn’t skewed by other investments.
The target year is identified in the name of the fund, e.g. Fidelity ClearPath 2045.
When choosing a fund, check the asset mix, which can be dramatically different between funds. You can find funds made up entirely of index funds or funds that are actively managed.
Understand the glide path, or how the asset allocation changes as you age.
Ones that drastically increase their fixed income and cash position a few years before retirement are suitable for retirees who plan to liquidate the funds to purchase an annuity.
Other funds maintain a bigger equity stake to continue to invest for growth.
Expenses must also be considered when choosing these funds. Look for low fees.
Here are two examples for an investor who wants to retire in 30 years:
1. Vanguard Target Retirement Fund 2045
- Holds 4 Vanguard index funds: approximately 90% equities and 10% bonds.
- 1-year return = 3.29%, 3-year return = 13.8%
- Average expense ratio 0.17%
2. BlackRock LifePath 2045
- Actively managed (10 funds).
- 1-year return = 1.25%, 3-year return = 10.94%
- Average expense ratio 1.26%
Target-date funds may make saving easy, but they can leave your investment a little light if fees erode your returns, or the glide path is too conservative too early on.
There are hundreds of existing funds available, each with their own fee structure, risk profile and asset mix making it a challenge to compare products and choose the one perfect for you.
You also need to contribute the right amount. Regardless of the chosen date, an underfunded nest egg is not going to support your retirement needs as it moves to a more conservative allocation.
Just because the fund says “2045” doesn’t mean that the return is guaranteed. A severe downturn in the market just before your target date can decimate the funds holdings. It’s important to know what investments the fund hold and the underlying risks.
Final Thoughts on target date mutual funds
Investors who are willing to choose their own portfolio assets and rebalance regularly may be able to achieve better returns on their own.
But investors who just want to designate a percentage of their money to retirement, and then forget about it for 30 years or so, may be completely comfortable with target retirement funds.
In fact, the popularity of these funds has been predicted to increase in the future.