If you’ve given some thought to retirement savings, you’ve probably encountered target-date funds. You choose this type of mutual fund based on the age you anticipate retiring. The funds keep an asset allocation tilted toward risk when you are young, and gradually dial down that level of risk as you approach retirement.
This type of mutual fund is a popular choice in many 401(k) plans and other retirement accounts.
For people who want a more hands-off investment style, target-date funds can be an attractive way to save. However, before choosing a target-date fund, ask yourself these key questions:
1. When do you plan to retire?
Most people choose a target-date fund based on when they plan to retire. You don’t need to know the exact date you plan to stop working, but you should have a ballpark estimate.
For example, if you are 30 and plan to retire at 65, you might want to choose something like the Vanguard Retirement 2055 Fund.
2. Which target-date fund strategy is best for you?
There are basically two types of target-date funds, according to FINRA (the Financial Industry Regulatory Authority).
- One type, called “to retirement,” stops changing the stock-to-bond ratio once you hit the date associated with the fund — such as 2055 in the example cited above.
- A second type, called “through retirement,” continues to adjust as time goes on.
To-retirement funds end up being less risky at the expense of seeing your investments stop (or almost stop) growing when you hit the target date. Some experts prefer the through-retirement option, arguing that it’s important to continue managing the balance as you age, rather than risk outliving your money.
3. What does it cost?
Of course, there will be fees. But they don’t have to be expensive.
In fact, all things being equal, you should choose the fund with the lowest fees. That doesn’t mean fees should be your only consideration when choosing a fund. But they should be high on your list.
Simply put, fees can destroy your nest egg. To learn more about the devastation fees can inflict, check out “Of All the Fees You Pay, This Is the Worst.”
4. How’s it managed?
Whether active management or passive management is more successful in boosting returns is an ongoing debate among investors.
Passive funds usually invest assets to reflect the makeup of a market index, thus tracking the ups and downs of that index — typically, the Dow Jones Industrial Average or the Standard & Poor’s 500 index. These index funds provide broad market exposure and low operating expenses. They’re not terribly exciting, but they take a lot of the guesswork out of investing.
Generally, actively managed funds will cost you more. Some people claim these costs are worth it, arguing that an actively managed fund can net you a higher return if you have the right manager.
Money Talks News founder Stacy Johnson is deeply skeptical of such claims, though. As he has written in the past:
“There’s a mountain of evidence suggesting market timing is tough. For example, despite the fact that mutual funds employ both the smartest people and best technology on the planet, the average professionally managed mutual fund underperforms a simple, unmanaged index.”
5. Do you really need it?
Basically, a target-date fund helps shift your portfolio from stocks to bonds as you get older. It’s something that you can probably do easily enough by yourself, or with the help of a financial adviser — especially if you’re mostly in index funds anyway.
Some people prefer the hands-off approach, so they don’t have to worry about rebalancing their investments. But if you have the time and inclination to do the rebalancing yourself, you may do well to skip the target-date fund and its fees altogether.
What’s your experience with target-date funds? Share with us in comments below or on our Facebook page.
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