Learn What a Target Date Fund Is and How to Use It
Many 401(k) plans offer something called a target date fund as one of the investment choices. 'Target date' means your target retirement date. It doesn't mean you have to retire then—it just means that the date estimates when you think you would retire.
What a Target Date Fund Is
A target date fund has a calendar year in the name of the fund, such as Target Date Fund 2020, Target Date Fund 2030, Target Date Fund 2040, and so on.
The investments inside a target date fund are being professionally managed to meet the needs of someone planning to retire near the calendar year that appears in the name of the fund. The investments are also being changed so that as you get closer to the retirement target date, you are invested more conservatively.
Why You Should Use a Target Date Fund
Target date funds are designed to offer one-stop shopping. First, you pick a fund that has a target date that is closest to the year in which you think you will retire.
Next you put all your money into that fund and you can do so confidently because the fund is not a single investment—instead, it owns lots of investments put together in a specific way. It is designed to create a diversified portfolio for you, and the fund automatically makes appropriate changes to your asset allocation so you are invested more conservatively as you near retirement.
People Don’t Use Target Date Funds Correctly
Target date funds are a great choice to get professional money management at a very low cost. Unfortunately most 401(k) plan participants don’t understand target date funds.
In one survey when 401(k) participants were asked, “Do you need other investments with target date funds?” 75% of the respondents said yes.
This is not true. Target date funds spread your money out over numerous different asset classes, usually by owning other funds. Even though it is one fund, it offers all the diversification the average person would need.
The Advantage of a Target Date Fund
The advantage of using a target date fund is that you do not have to pick ten different funds in the right proportion; the fund is doing this for you. And the investments are chosen to provide the probability of a good outcome for someone retiring near the calendar year that is in the name of the fund.
Most 401(k) plans now offer a target date fund option, but if you don't have a 401(k) you can still use a target date fund, including picking one from this list of target date fund groups.
For Businesses and Solo Investors Alike
According to James Gambaccini, certified financial planner and managing partner of Acorn Financial Services, "Target-date funds are very easy to deal with for automatic enrollment for the employer, helping them serve their fiduciary role." In addition, "They can offer a very diverse portfolio in as few trades as possible for the employee," he said.
Sterling D. Neblett, CFP, founding partner of Centurion Wealth Management says target-date funds are also an excellent option for the amateur investor who wants to set their portfolios on autopilot because they are typically automatically rebalanced and reallocated as target retirement ages are reached.
"I would strongly argue that the target-date fund would do a much better job aligning with the investor's goals than the investor would do on their own," said Neblett.