When you invest in a retirement account, rebalancing your portfolio on a regular basis is wise. Different investments come with varying levels of risk, and taking a more conservative approach as you age can help provide a more secure future.
However, rebalancing your investments takes time. Plus, many people fear they don’t have sufficient knowledge to make smart decisions on what kind of strategy makes the most sense for their particular time horizons and risk appetites.
What makes a target date retirement funds particularly attractive, is the rebalancing activities are managed by a professional. Target date funds are often mutual funds or other types of investment funds that consistently rebalance themselves based on a certain date.
These dates are those closest to the client’s retirement date. In the early stage of your target date fund, the funds are more aggressive, as you move forward to your horizon date or retirement date they get more conservative to ensure you don’t have major investment losses right around the time you’re ready to retire.
Also known as age-based funds, dynamic risk funds or lifecycle funds, they are structured to address a capital need at a future date. This date is usually included in the name of the fund, and a mutual fund family will have a group of target dates in five year increments.
Your Mileage May Vary
When it comes to investments, the rate of return is a big factor. First and foremost, the goal is usually to beat inflation, which averages around 2 to 3 percent historically. This allows you to experience meaningful growth.
Not every target date retirement fund gets the same level of return. Some may only achieve about 4 percent while others can reach over 7 percent.
For funds on the lower end, this suggests they aren’t typically outperforming the stock market, which has an average annual return between 7 and 8 percent.
However, it’s important to note that risk impacts the average performance of the target date retirement funds with a particular broker.
Funds with more imminent target dates usually have more conservative allocations than funds with target dates that are further out in the future — those with target dates that are furthest in the future usually have larger annual performance figures than the funds with more imminent target dates.
So when you look at target date funds, it’s very important to review the performance of each of a company’s target date funds instead of just the an overview of all the target date retirement funds.
Target Date Retirement Funds Aren’t Risk Free
Typically, target date retirement funds reflect a diverse range of investments. Some are comprised of a mix of individual stocks and bonds while others focus on mutual funds.
While diversification can lower the amount of risk, that doesn’t mean target date retirement funds are risk free.
Fund performances can vary dramatically, and the state of the economy can impact nearly any investment.
Consider the Credit Crunch
For example, during the credit crunch of 2007 to 2009, 264 target date funds offered by 39 mutual fund firms performed poorly.
Even those in a conservative investment phase, typically designed to produce income, experienced an average loss of 17 percent. The riskier options, catering to those retiring in 2055, lost 39.8 percent of their value.
Although the 2007 to 2009 recession cannot be considered standard market conditions, it’s important to realize that similar events can yield those type of results.
Composition Varies Dramatically
Additionally, just because two target date retirement funds have the same year in their names doesn’t make them equal.
The target date listed in the name of a fund does not denote any kind of standard whatsoever.
Exactly when in its lifespan a target date retirement fund begins to reallocate toward more conservative strategies will vary from one fund manager to the next. Along with that, the exact combination of stocks, bonds, and exchange traded funds in the portfolio of each fund can differ considerably.
This means that two funds can produce significantly different results even if they have the exact same target dates.
A fund’s performance is dictated by its composition, so, unless two funds are identical, they won’t experience the same gains or losses.
Don’t Put It on Autopilot
What makes target date retirement funds appealing is the ideal of an investment that supposedly does more of the footwork for you than other types of retirement planning products.
However that’s more of an ideal than a reality — so you still need to monitor the performance of target date retirement funds.
Ultimately, any investment can under- or outperform your expectations, so you need to keep an eye on its value.
Additionally, if you have additional investments outside of the fund, you may need to review your overall asset allocation.
Otherwise, your total investments may be more conservative or risky than you intended.
Should You Invest in Target Date Retirement Funds?
Ultimately, how to invest is a personal choice. If you’re interested in target date mutual funds, make sure to do your research. Look at the fund’s past performance and current allocations.
See how often it’s rebalanced and don’t forget to factor in any fees associated with the fund, as that can quickly eat away at any gains.
Readers, have you ever invested in a target date retirement fund? Tell us about your experience by posting in the comments section beneath this post.
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