Target-Date Funds Might Not Be Helping as Much as You Think They Are

For people unfamiliar with investments such as stocks and bonds, much less things like options and futures, mutual funds have been a helping hand. Anyone who’s had a retirement account to which they’ve contributed, such as a 401k, 403b or IRA, probably is somewhat familiar with them. A mutual fund is a managed investment fund that holds a collection of various securities such as stocks and bonds with a specific investment objective.

Mutual funds might hold a diverse selection of assets, but simply holding a mutual fund doesn’t make your portfolio diversified. A fund with a name like “blue chip growth” tends to hold only large-cap stable companies found in the DJIA and S&P 500. That might not seem like a bad thing, but if that’s all you own, you’re missing out on mid-cap and small-cap stocks as well as value stocks and bonds.

The other issue many people have with investing for retirement is understanding how asset allocation works. On the surface, it seems simple: you invest more in riskier high-growth assets, such as stocks, because you’re younger and have more time to recover from down markets. As you get closer to retirement, you slowly shift your focus away from stocks to more conservative investments like bonds.

Of course, understanding how each asset should be split and when to change them can require a bit of legwork and know-how. If you aren’t an investment professional, this process may be intimidating. The financial industry came up with a solution to this problem with target-date mutual funds – a single investment that holds other mutual funds and automatically changes stock/bond allocation according to the target date selected on the fund. It’s designed as a “set it and forget it” investment, but if you invest in one, you might not be getting all the benefits you think you are.

The primary goal of a target-date fund is the automatic allocation adjustment that takes place over the life of the fund. While diversification is achieved, it might not be the best fit for you according to your risk tolerance. These funds tend to err on the side of caution, leaning toward a more conservative approach rather than an aggressive one. If you’re attempting to invest for the long term for retirement, you might not see a high rate of return over time.

Fees also can be an issue in these types of all-in-one investments. Mutual funds already have an expense ratio, or fee, built in for management of the fund. A target-date fund could hold a collection of mutual funds, each with different fees that you can’t control – not to mention the fee associated with the target-date fund itself. In an already conservative fund, these fees can hurt overall returns. If you earn 6% on your investments but the fees add up to 1%, you’re only taking home 5%.

A well-balanced target-date fund may be beneficial for individuals who aren’t adept at managing their retirement accounts or who are risk-adverse. However, it doesn’t take much extra time to allocate investments yourself. A simple check once a year only takes a few minutes and could save you money on fees otherwise spent paying someone to do it for you, and that translates to higher returns on your investments. Keep in mind that target-date funds can be helpful investments, but might not be the bargain you want.

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