A target-date fund can be an excellent investment tool for hands-off investors who are near or already retired.
With target-date funds, investors can obtain a suitable, stable risk-return profile through asset allocation.
As your retirement draws near, the fund will periodically and automatically readjust its investments, following the performance of a safer asset mix, such as ramping up your bond holdings and reducing your stock holdings.
Still, a target-date fund has advantages and disadvantages that should be considered carefully.
Why Consider a Target Date Fund?
1. Helps Young Employees
A target date fund can be significantly helpful to you if you’re a young employee. That’s mainly because of the amount of time you have.
You have a long investment horizon as someone working in their 20s or 30s. Therefore, in a target date fund’s early year, your investments should primarily include stocks since they are typically a good bet for generating long-term returns.
2. Instant Diversification
A single target date fund can provide you with a well-diversified portfolio of domestic and international stocks and bonds.
In addition, target date funds’ asset allocation is readjusted as you near retirement. So, if you’re investments were initially focused on stocks, the fund will shift the focus to bonds as you prepare for retirement.
3. Rebalances on the Investor’s Behalf
Target date funds are built to perform the rebalancing on the investor’s behalf.
While an investor’s risk tolerance becomes less and less as they age, they may still end up with an investment portfolio that doesn’t align with their needs. For example, a market in a solid bullish condition could leave you having too much money in stocks and fewer bets on bonds.
With a target date fund, you could go for years without checking your retirement investments and remain appropriately invested.
Why Think Twice About Opting for a Target Date Fund?
1. One-Size-Fits-All Nature
The one-size-fits-all nature can be a huge disadvantage of target-date funds since this makes the fund quite incapable of considering or adapting to the current state of the economy.
For example, a target date fund’s default concept is that bonds will always be less risky than stocks. However, this is not entirely accurate in all economic situations, especially right now when we are seeing higher inflation and interest rates.
Because of this one-size-fits-all nature, investors can be caught off guard during unexpected economic events.
2. Lack of Diversity
Target-date funds have a simple design, but this may not work for some investors who may need a broader mix of assets than stocks and bonds. That’s because they may have to consider more than their estimated retirement year, like existing assets such as their real estate or savings.
3. Complicated Fee Structure
The fee structure of a target-date fund can be complicated to grasp, as it has a management fee plus a fund-of-funds management fee.
That means your target-date fund portfolio doesn’t only have one mutual fund. Instead, it consists of several mutual funds with different expense ratios.
Therefore, you should properly research what the firm may charge you, as the fee structures vary depending on the fund company.