How Can I Grow My Money with Target Date Retirement Funds?
When it comes to financial planning for retirement, there are several different investment vehicles available, including stocks, bonds, mutual funds, CDs, money market accounts, and government bonds. Each investment vehicle offers its own advantages and risks.
Stocks can appreciate quickly; however, they are also volatile and can easily depreciate. CDs, on the other hand, are deemed “safe,” but their current rate of interest no longer keeps up with inflation. Mutual funds offer some protection against market volatility; unfortunately, their profits are often diminished by trade, load, and other fees.
As a result of these challenges, many individuals who are setting up their retirement accounts choose target date retirement funds — also known as life cycle funds — as their investment vehicle of choice.
What Are Target Date Retirement Funds?
Target date retirement funds are mutual funds that operate under an asset allocation formula that is set for a specified retirement year. As this retirement year approaches, the formula adjusts the asset allocations of the fund from aggressive (growth-focused) to conservative (fixed income-focused). The goal of this adjustment is to protect investors from market fluctuation as they reach retirement age and enable them to have the capital to draw from immediately upon retirement.
Target date retirement funds start with the assumption that an investor will retire in a certain year — for example, 2060 — and based on that year, the fund formula selects different percentages of equities. With each passing year, the formula resets these equities percentages, gradually moving away from higher-risk growth stocks to fixed income equities like bonds and dividend-bearing stocks. This gradual change in a fund’s investment mix is termed its glide path.
The target retirement year is typically included as part of the name of the fund. So, an investor who plans to retire in the year 2060 would invest in a fund called, for example, the XYZ Target Retirement 2060 Fund. This fund would probably have a high ratio of small cap and tech stocks set for growth over the next 40 years. Conversely, an investor planning to retire in 2030 would invest in a fund called, for example, the ABC Target Retirement 2030 Fund. This fund would contain a higher ratio of bonds and dividend-bearing real estate investment trusts.
Are Target Date Retirement Funds Suited for Me?
If you don’t wish to spend a lot of time worrying about your investments, or if you don’t have the time or desire to plan your retirement, then the “set-it-and-forget-it” approach of target retirement funds will be of benefit to you. These funds also automate your risk adjustment over time, so you aren’t caught off-guard by market volatility as retirement approaches.
Many target date retirement funds have fees comparable to those of standard mutual funds — but not all. In fact, CNN Money reported that some funds have rather high expense ratios of 1.02 percent. These high fees can quickly undo the profits that are realized by the fund or even have it fall below the yearly inflation rate. In contrast, index funds often have expense ratios of less than 0.10 percent.
Another factor to keep in mind is that target date funds are funds of mutual funds, so you may end up paying two fees: one for the retirement fund itself and another for the management fees of the underlying mutual funds. This fund structure and its associated costs have even come under the scrutiny of Congress.
Finally, because different firms manage their target date funds differently, there is no benchmark by which you can analyze fund-to-fund performance. In contrast, a fund like an S&P 500 index fund can be compared against the actual S&P 500. The lack of actual comparison data is something to be aware of when selecting target date funds for your 401(k) or other retirement accounts.
Where Should I Start with Target Date Funds?
You can utilize websites such as The Motley Fool and Investopedia to gather information about specific target date funds and their associated fees. Quite often, these websites recommend the most value-conscious funds available, taking a lot of the guesswork out of fund selection and comparison.
For the most up-to-date information, you should also go to the actual website of the investment firm or bank that operates the fund. For example, to obtain all information about the Vanguard Target Retirement 2040 Fund, you should search the mutual fund offerings at Vanguard. Be sure to look up fees of every fund that you research, including possible purchase and redemption fees. Account service fees may also exist, especially for target date funds that are added to IRAs, 403(b), or 401(k) accounts.
While there are numerous target date funds available through different institutions, here are some example funds that offer good returns and reasonable fees.
Vanguard Target Retirement 2065 Fund
This long-term fund has an expense ratio of 0.15 percent, a minimum investment of $1,000, and is allocated between 90 percent stocks and 10 percent bonds. Since its inception, this fund has posted a return of 5.17 percent.
Vanguard Target Retirement 2025 Fund
This near-term fund requires a $1,000 minimum investment and has an expense ratio of 0.13 percent. Its portfolio allocation is 61.9 percent stocks and 38.1 percent bonds. This fund has enjoyed an average return of 6.52 percent since its inception.
T. Rowe Price Retirement 2030
This mid-term fund has an expense ratio of 0.67 percent, and portfolio allocation of 72.6 percent stocks, 24.8 percent bonds, and 2.6 percent other, convertibles, and preferred holdings. The account opening minimum is $2,500. It has posted an average return of 8.61 percent since its inception.
Charles Schwab Target 2040 Fund
This fund has an expense ratio of 0.67 percent and no minimum investment. It is set to be distributed at 40 percent in equities, 54 percent in fixed income, and six percent in cash investments at the time of its maturity. The fund has averaged 7.06 percent in annualized returns since its inception.
Which Target Date Fund Is Right for You?
There is no hard and fast rule as to which target date fund is best for you. While it pays to look for funds that have the lowest fees, you should also look at their historic rates of return and asset allocations. By shopping around for funds and comparing their pros and cons, you will have a better understanding of the benefits and risks of this particular investment tool.
Keep in mind that there is also no rule that you must invest in a specific fund based on your expected retirement year. For example, if you are 40-years-old and feel that your selected fund has a stock allocation that is too high, you can always invest as if you are 50-years-old, or even 60-years-old. In so doing, you’ll limit your exposure to market volatility, especially during bear years and recessions, protecting your retirement nest egg from sudden depreciation.
Overall, while target date retirement funds do cost money to set up and maintain, they can offer investors a good balance between growth and stability during both their employed years and retirement.