The ABCs of Target-Date Funds
Here's a primer.
Megan Pacholok: Saving for retirement can be a daunting task. Balancing asset-allocation decisions with selecting underlying funds, monitoring investments, and setting up a rebalancing schedule can be time consuming. A simple solution, often referred to as a “set it and forget it” option, for retirement savings are target-date funds. But what is a target-date fund? How do they work? And what are some of their key features?
Let’s take a look at the ABCs of target-date funds.
A target-date fund is intended to be your total retirement portfolio. The “target-date” is referring to your ideal retirement year, which is usually when you turn 65. A target-date series is comprised of several target-date funds issued by the same provider. A series typically includes funds in five-year increments. So, for example, if you’re planning on retiring at 65 and are currently 25, you should be looking at funds with a 2065 target-date. If you are planning on retiring in 10 years, the 2030 vintage is more suitable for you.
When referring to a target-date provider, we are talking about the asset management firm that manages the target-date series. A target-date provider can, and often does, offer more than one series.
Another term typically thrown around when discussing target-date funds is glide path. Well, what is a glide path? It refers to a target-date fund’s preset asset allocation along the retirement journey. Typically, they start with a higher equity allocation, and as they get closer to retirement it comes down. It usually averages 92% in the beginning and around 43% at the retirement date. The downward slope of equity allocation forms the glide path. Target-date funds can have very different glide paths and finding the right one is going to depend on your risk tolerance.
But what about the “to” versus “through” glide path debate? A “to” retirement glide path lowers its equity allocation until the target-retirement date. At that point, the equity allocation remains consistent, while a “through” glide path tends to own more stocks at retirement because it continues to de-risk and brings down its equity allocation for another 10-20 years from the retirement date.
Cost is also an important investment consideration. You should be aware of how much you’re paying for a target-date fund. The fees typically reflect the underlying funds managers are using. Series that invest in passive funds tend to be a bit cheaper, whereas those with active managers tend to cost more.
There is a middle-of-the-road option known as blend strategies. A target-date blend series finds a balance of both passive and active funds. Target-date managers can include active managers they have conviction in and keep costs lower by including cheap index where markets are more efficient.