What is a Target Date Fund?

Hi everyone, and welcome back to Melissa Making Cents!

On my, and every other CERTIFIED FINANCIAL PLANNER™'s, journey, I've found that retirement is one of the most popular requested topics! Just about any financial coach could tell you that there's no one-size-fits-all for financial planning, especially not when it comes to retirement! Everyone's goals, income, and lifestyle are so unique that it really takes some sitting down and figuring it out.

The golden years are something that we all strive for! We can finally be DONE with working Monday to Friday and enjoy the time we have with our loved ones and family. However, the number of people who have taken no steps towards achieving their retirement goals is enormous. Alarmingly, a whopping thirteen percent of Americans who are sixty or older don't have a retirement savings at ALL.

But that begs the question… when do we start saving for retirement? How much do we need to save? How long do we need to save? Hopefully, some of those mysterious questions can be a little more illuminated for you as we tackle today's topic – Target Date Funds.

What's a Target Date Fund?

Now… I realize that a target date fund is something a lot of people probably haven't heard of, especially if they haven't even considered saving for retirement. What comes to mind when you first hear "target date fund"? Are you thinking of a savings bucket to donate some money to each paycheck so that you and your significant other can have a great time buying silly stuff at a target date? Uh… yeah, that wasn't my first thought either (looks around nervously).

But in all seriousness, a target date fund is an actual financial term used to describe a fund that saves for retirement. So if we break down the name, it's easy to understand! The "target date" is the target date that you hope to be able to retire, and the fund is what you contribute to and manage to get to that point.

How does a Target Date Fund Work?

In reality, a target date fund is an investment vehicle. Target Date Funds, and other funds like them, are also referred to as lifecycle funds. These are typically mutual funds or ETFs where the brunt of risk is taken on the front-end and tapers over time (as you near retirement). In essence, these funds are designed to have a relatively predictable rate of return to get you across the finish line. If you think about it, being set up this way makes a lot of sense. You contribute more and take on more risk in the early stages of a target date fund because it wouldn't be as devastating to experience a market decline when you're young and in your working years. However, as retirement age draws near – we become more conservative in our investing efforts because we don't need as much rapid growth and don't want the inherent risk that comes with high returns.

Why Choose a Target Date Fund?

Well… target date funds are something that just sort of make sense! You know that you'd like to retire one day, and you can't work forever. Utilizing a target date fund, you can put some sort of stamp down that says, "this is my goal, and this is what I'm working toward." It allows you to more easily plan for your future and retirement and make goals for yourself along the way! Essentially, using a target date fund takes some ambiguity out of retirement, which is important because people often feel like retiring is one of those far-away goals that won't ever materialize.

However, many people choose to use target date funds to save for retirement because of the risk/reward concept! For example, suppose you're planning to retire either in a specific year or with a specific money amount. In that case, you don't want your investing strategy to be ultra-rigid. Instead, you want something that grows and matures as you do. TDFs do just that by tapering off risk as you near your goals.

Are Target Date Funds Only for Retirement?

That's a great question that comes up a lot! While Target Date Funds are most frequently used to save towards retirement, there are other uses for them that are becoming more prevalent! More and more often, people are using TDFs to save towards significant life events or purchases. Young people saving for cars, houses, their children's college, or starting businesses can also use target date funds, and the concept works similarly!

While it isn't for everyone, using a target date fund to save towards significant events makes sense for the same reason that using them for retirement makes sense. You're just taking the same concept and shrinking the money amount and timeline. Using a target date fund gives you a hard-set date and monetary amount to strive to reach, which can make all the difference psychologically when saving.

Are All Target Date Funds Made Equally?

Not all target date funds are created equal. While some target date funds are great deals and are worth your time and money, others could potentially charge insanely high management and administration fees. What's important here is that you're communicating with your financial planner or financial advisor to be sure that you're making the best possible decision for your specific scenario!

Perhaps you're saving for something low-cost or have a short timeline, or maybe the target date fund you're looking at doesn't have a great return on investment. Or maybe there's an even better opportunity to make more money with your investment, risk aversion, and timeframe that you haven't considered.

Another essential thing to note is that a target date fund may just flat out not be the right financial choice for you to begin within a given situation. This is another reason that clear communication of your goals and timeline with a financial planner is important when considering investing opportunities.

Are Target Date Funds Risky?

This is the part of the article where I remind everyone that any investment has an inherent and unescapable risk. And that's undoubtedly true for TDFs as well! The thing about TDFs is that they're as risky as the fund that they're investing in. However, as far as investments go, they're relatively low risk. Remember that with target date funds, you take on the majority of risk at the beginning of the investment's lifecycle and (theoretically, at least) taper it by investing more conservatively as time passes and you near your goals.

Make sure to speak with a financial professional to be sure that the TDF you're interested in is well-designed and disperses risk properly through diversification. It's also likely that your TDF will have a lifetime plan of what it's going to invest in and when likely based on benchmarks and time. However, it's essential to monitor this and make changes and adjustments as time goes on. Doing so will reduce the amount of risk associated with these funds.

Critics of the Target Date Funds

Like anything else, target date funds have critics. As tempting as it might be for many (especially when they're interested in something), we can't overlook the concerns that some may have about target date funds which will help us make more informed decisions.

For instance, some of the criticisms pointed out by others about target date funds are that some of them are more costly than you may believe. High fees and charges can stack up and negatively affect your return in the grand scheme of things. There's also a concern that many financial planners express that people are too interested in TDFs being "set it and forget it," which could cause issues down the road as investments may need to be adjusted. Last, but certainly not least, some worry about the ability of a TDF to properly account for inflation over the years. You certainly don't want to be in a situation where you've invested money in something for retirement but come out with less "real wealth" than what you put in over the years when adjusting for inflation.

I find that though these are all valid concerns for TDFs or any investment, the reality is that you must search for and find the right fund for you. It's easy to get stuck in the rut of saying, "Okay, I need a target date fund," and then settling for the first one that crosses our desk. However, as I've said – not all TDFs are created equal, and the hunting process to find a quality TDF that fits your goals and vision is perhaps the most critical part of the equation.

Active or Passive? Do Target Date Funds Stop Working?

According to some, most investments can fall into one of two categories. These categories are active and passive – an active investment is hands-on and requires regular adjustments and maintenance. In contrast, a passive investment is considered to be "set it and forget it."

However, many others believe there's no such thing as a truly passive investment. Anything you invest your money in should be worth your time. Even if you aren't going to sit at your computer spilling over numbers for hours on end, you should always be aware of how your investment is performing and be able and willing to either adjust it as needed or have someone, like a financial planner, who can make those adjustments for you.

Regarding target date funds not working, that depends on how you define "working" and "not working." The growth rate of a target date fund will decrease over time, but that's by design. As we get closer to retirement, we don't necessarily want our money tied up in risky investments. Instead, we prefer to have them slowly migrate to lower-returning investments that have less risk.

Simplicity VS Precision

Perhaps one of the most valid criticisms of target date funds is that they value simplicity over precision. Being a largely passive investment that's meant to get you across the finish line to retirement may mean that your TDF performs largely conservatively throughout its life. That's because these aren't designed to be a get-rich-quick investment; they're designed to be as predictable as possible and ensure that the fund holder can retire by the time they want to.

A more actively managed investment may be able to provide more significant and quicker returns than a target date fund; however, we must remember that's the point. Less return, but less profit. We also must remember that a target date fund shouldn't be the end-all-be-all of your financial plan or portfolio. Instead, this fund is designed to accomplish a single goal reliably.

Are Target Date Funds Worth it?

The truth is that whether any investment is "worth it" depends on the investor, their goals, their timeframe, and their risk aversion. Many target date funds are, in my opinion, "worth it" as far as accomplishing the goal of retiring by a specified timeframe. They're also "worth it" because they put pen to paper regarding saving and planning for retirement. The simple fact that they shift their holder's mindsets from "retirement is this ambiguous and elusive beast that I'll never be able to attain" to "retirement is something that I'm planning on doing, and this is the date when it should happen for me" is an accomplishment. However, performance over time and goal-accomplishment of getting to retirement are the true metrics of success here, and they do largely accomplish this goal. 

The best way to choose a target date fund or any retirement account or plan is to talk to a financial adviser. Get in touch with someone with whom you can share your goals and help you find a target date fund that works for the purpose you want it to. As we discussed earlier, a target date fund isn't just a retirement account anymore – they can be used for all sorts of things. That's why it's crucial to get in touch with someone who can help guide you through the decision-making process and find which target date funds are worth your time and can help you accomplish your specific goals in the timeframe you have in mind.

If you're considering purchasing a target date fund or planning retirement, please call or email to schedule an appointment with me. We can create a financial plan incorporating your specific goals and retirement plans.

Until next time...this is Melissa Making Cents!

Melissa Anne Cox, CERTIFIED FINANCIAL PLANNER™, is a College Planning and Student Loan Advisor and Financial Coach in Dallas, Texas.