Key takeaways
- A target date fund is a simple, one-choice investment option for hands-off investors.
- The funds provide a diversified mix of investments appropriate for your age and investment time horizon.
- Objectives and risks gradually shift from aggressive to conservative over time—automatically.
“There are so many investment options in this plan I don’t know where to begin.” Sarah and Alex were trying to decide how to invest Sarah’s retirement savings in her employer’s 403(b) plan, and clearly getting overwhelmed by the number of options. “It’s like searching Netflix trying to build a cue of shows in every genre that we’ll be comfortable watching for years to come!” lamented Alex. “There’s got to be a simpler way.”
Pick one and you’re done
There is a simpler option that’s offered in many 403(b) retirement plans: target date funds. A target date fund, sometimes called a lifecycle fund or target retirement fund, is a fully diversified, complete investment strategy wrapped up in a single fund option. Their popularity among investors continues to rise every year. As of June 30, 2017, there was approximately $1 trillion invested in target date funds.1
Each target date fund has a date (year) in its name. This represents the year an investor expects to retire (give or take a few years on either side) or to begin withdrawing money from the fund. Generally, the funds are designed for investors to put 100% of their retirement plan savings into the fund with the date closest to their expected retirement date. In other words, pick one and you’re done.2
Let’s peek behind the target date curtain
Most target date funds from the major investment companies are a portfolio of mutual funds covering the major asset classes: U.S. stocks, international stocks, bonds and short-term cash investments. Think of it as a “fund of funds.” The percentage invested in each underlying mutual fund depends on the target date fund’s investment time horizon—the number of years from today to the year in the fund’s name.
A 2060 target date fund has a very long time horizon. This fund’s objective is to maximize long-term growth potential. Historically, stocks have been the way to achieve this goal, so a 2060 fund might have as much as 90% of its assets invested in various stock funds.
A 2025 target date fund has a shorter time horizon. This fund is focused on reducing investment risk, protecting principal and generating income (while still providing some growth potential) because investors will be starting fund withdrawals in just a few years. Typically, a 2025 fund might contain 60% stock funds, 30% bond funds and 10% short-term funds. These are just rough examples. Actual asset allocations will depend on the investment philosophy of the target date fund managers, and those strategies can vary quite a bit from one fund company to another.
Go from aggressive to conservative investing automatically
If you put all of your retirement savings into a single target date fund, that makes the fund selection process super simple. But what really makes a target date fund an easy and convenient investment option is that the fund’s investment strategy and risk level becomes more conservative as the target date nears.
Over the time horizon of a target date fund, the fund managers gradually shift assets out of stock funds and into bond and short-term funds. For example, our 2060 fund, which starts out with 90% stock funds and 10% bond funds, might have shifted to 80% stock funds and 20% bond funds 15 years later. And 25 years later, the asset allocation might have transitioned to 70% stock funds, 25% bond funds, and 5% short-term investments.
Along the way, the fund managers regularly rebalance the fund to keep the asset allocation steady over the short-term. This gradual transition (technically it’s called the glidepath) from an aggressive, stock-dominated strategy focused on growth, to a more conservative strategy focused on income and stability happens automatically. You don’t have to do a thing.
Keep your investment risk level aligned with your age
The gradual adjustment of a target date fund’s asset allocation is designed to keep the fund’s objective and risk level generally appropriate for your age, all the way to the target date and often beyond. It’s like generic professional investment management since investment decisions are being made for you but are not tailored to your individual needs.
For pure convenience, a target date fund is about as hands-off—and as simple—as you can get when deciding how to invest your retirement savings.
1. Source: Investment Company Institute https://www.ici.org/trdf
2. An investment in a target date fund is not guaranteed at any time, including on or after the target date. Diversification does not ensure a profit or protect against a loss.
