A lot of investors make target-date funds (TDFs) a core part of their portfolios, but many don’t commit to target-date funds as their entire strategy.
Sure, there’s nothing wrong with sprinkling in sector funds or stocks to add a little extra exposure to specific areas of the market. But investors who mix target-date funds with other long-term equity or fixed income products could be inadvertently sabotaging their investment goals. As of 2016, nearly one-third of target-date fund investors continue to mix target-date and non-target date funds. This could lead to skewed asset allocations, over-diversification and potentially poor risk-adjusted returns.
In case you are wondering whether mutual funds are right for you at all, you should read why mutual funds, in general, should be a part of your portfolio.
Who Are These ‘Mixed’ Investors?
A target-date fund strategy is one in which investors put their money in a portfolio with a pre-determined asset allocation that grows progressively more conservative as the target date approaches. It does this to focus on capital preservation instead of riskier investments as the time to withdraw the money comes close.
Investors who mix TDFs and non-TDFs generally do so for a few reasons. Mixed investors also tend to be more sophisticated in nature. These folks keep part of their portfolio in TDFs as a long-term strategy, but also choose non-TDFs to take advantage of opportunities they see to outperform the market. Some mixed investors come as a result of employer actions. Many companies make matching contributions in employee stock, for example, and that can skew how they are directing their own investments.
Know why custom target-date funds can be a better option than the traditional ones here.
The Case for Committing to TDFs Only
The reason why people should stick with only target-date funds is pretty simple. They are designed to be all-in-one investments already. These funds are meant to provide investors with age- and risk-appropriate portfolios and any investments beyond the target-date fund itself could skew one’s overall asset allocation and potentially make their portfolio more or less risky than they want. Mixing funds could leave individuals over-concentrated in a particular area of the market or building a portfolio with too many overlapping holdings.
TDFs are also built to be cheap. Providers of these funds generally understand that fees are one of the biggest hindrances to achieving investment goals. Add-ons to target-date funds, especially actively-managed funds, can come with high fees, further hindering the ability of an investor’s overall portfolio to maximize returns.
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When Mixing TDFs and Non-TDFs Could Make Sense
Despite target-date funds making solid investments in and of themselves, there are still cases where adding a non-TDF makes some sense.
Close market watchers might eye a potentially undervalued asset class or sector of the market and wish to overallocate to it in an attempt to juice returns. This can really only be accomplished with a non-TDF, since TDFs generally execute little to no active management within their portfolios. Along the same lines, investors might wish to tilt their portfolios toward either the more aggressive or conservative side depending upon market conditions or personal risk preferences.
The asset allocations of TDFs can vary significantly across providers despite having the same target date. If you don’t like the allocation of the fund with your target date, you can either switch to a TDF with a different target date, if one is available, or add an equity or fixed income fund to your portfolio to adjust the overall risk level.
Either way, mixing TDFs and non-TDFs can be a means of adjusting the portfolio to meet your specific goals and risk tolerances.
The Bottom Line
While target-date funds make great standalone investments, they can also be effectively paired with non-TDFs in the right setting. One of the drawbacks of TDFs is that they aren’t geared toward any one particular investor. In many cases, the addition of a non-TDF can be an ideal way of making your portfolio a better fit for you personally.
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