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But what exactly are they? How do they work? And perhaps more importantly, are they a good fit for your portfolio?
Typically, a TDF will swing from a portfolio mix containing a lot of stock investments in the early years, to a mix-weighted portfolio of bonds and cash later. The further out the target date, the more aggressive the fund will be. Conversely, the closer the target, the more conservative the fund will be.
The problem with glide paths is that not every one is the same. Each fund sponsor has its own unique take on just how much in stock, bonds and other assets an investor should have at each stage of life. However, even with this, target-date funds not only provide instant diversification, but diversification that changes as risk profiles decrease.
A “to” fund is designed to get you to that target date. The fund will be at its most conservative then and hold that allocation forever. The idea is that the investor in the target-date “to” fund will use the pot of savings all at once or transfer to another vehicle for continued income generation.
A “through” fund will hit retirement — or the target date — with slightly more exposure to equities and continue to become more conservative until about five or ten years after retirement. The idea here is that investors will still need plenty of growth to power them through their golden years. Investors can start withdrawing from the fund while still getting some sort of actual return.
Target-date funds accomplish their asset allocation goals by investing in other mutual funds sponsored by the same firm. There are two kinds of fee structures at play here. One is called a “roll-up” fee structure in which the expense ratio listed on the target-date fund is what investors will pay. It includes a small management fee plus the expense ratios for all the underlying mutual funds it holds. These TDFs are often the lowest cost available. However, some funds don’t use that structure and essentially “double dip” on their fees. All in all, many quality low-cost, target-date funds can be had for less than 1% in roll-up fees.
Investors also need to look at just how the fund is diversified. If a target fund owns several chronically underperforming actively managed funds, all the diversification in the world isn’t going to save it. Conversely, the target date funds from Vanguard only have four holdings, but provide access to every stock and bond across the globe.
A final thought on TDFs also comes down to risk. Target-date funds assume that risk profile is tied to age. But that may not be true for you. An individual investor may or may not want to dial up or dial down their risk exposures. To that end, choosing a later or earlier dated fund could be a better bet.
That said, TDFs are not foolproof.
Investors still need to do their research before pulling the trigger on any target-date fund. There’s plenty of factors that need to be considered.
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