In recent years, target date funds have emerged as a very popular addition to 401(k) retirement plans.
They provide investors a “set and forget” option for their retirement portfolios – but what are they, how do they work, and are they worth it?
The traditional playbook to save for retirement is something that most financial advisors and investing experts agree upon.
When you’re young?
You want to invest in riskier assets like stocks
As you get older?
You want to transition to lower-risk assets that create income, like bonds
Younger people have more time to ride out fluctuations in the stock market, because they won’t need the money for decades. On the older side of the spectrum, retirees want stable and secure investments that will allow them to enjoy their golden years.
Introducing the Target Date Fund
In your long journey to retirement, you could adjust your portfolio manually to go from riskier assets to safer, income-producing ones.
But, interestingly, there are also products out there that do this automatically as well. They are called “Target Date Funds”, and they are becoming very popular in retirement plans.
Here’s what they are, and how they work.
1. Funds are named based on a target date of retirement
i.e. “2055 Fund” is built for those expecting to retire in 2055
2. You buy the fund closest to your expected retirement date.
i.e. If you are 24 years old, and expect to retire at age 65, then buying a fund set for 40 to 45 years from now makes sense
3. Over time, the fund makes adjustments to its portfolio based on that retirement age
i.e. It will gradually decrease exposure to risk over time, and increase income-producing assets like bonds. This is called the “glide path”.
For most people, target date funds can be a great “set and forget” option for retirement saving. But, before committing to a target date fund, make sure to look under the hood to know what you are getting.