When it comes to saving for retirement, many people turn to employer-sponsored plans like 401(k)s. In these plans, one of the most common investment options is a target date fund. But what exactly are target date funds, and should they be part of your retirement strategy? Let’s break it down.
What Are Target Date Funds?
In simple terms, target date funds are mutual funds designed to grow your retirement savings over time. The “target date” refers to the year you plan to retire. These funds are an automatic and hands-off option for many retirement savers because they adjust the investment mix over time to match your retirement timeline. Sometimes they are called ‘horizon funds’ because they’re tied to your long-term financial horizon—your retirement date.
For example, if you’re 35 years old and planning to retire at 65, you’d likely choose a target date fund that has a target year of 2050 or 2055. These funds typically come in five- or 10-year increments, so there are plenty of options for different retirement timelines.
How Do Target Date Funds Work?
Target date funds are designed with one thing in mind: to gradually become more conservative as you approach retirement. When you are far from retirement, such as in your 30s or 40s, the fund will be weighted more heavily in stocks. Stocks offer greater growth potential but also come with higher risk. However, with decades until retirement, you can afford to take on some risk and ride out any market volatility.
As you get closer to retirement, the fund automatically rebalances to include more bonds and other less risky investments. By the time you’re within a few years of retiring, the fund will be more conservative, helping protect your money from market downturns.
For example, someone in their 30s might have 80% or more of their portfolio in stocks, but by the time they’re nearing retirement age, their portfolio could be 50% bonds or more. This gradual shift in asset allocation is meant to reduce risk while maintaining some growth potential.
Where Can You Find Target Date Funds?
You’ll find target date funds in many types of investment accounts, including:
- 401(k): These are common in employer-sponsored retirement plans.
- IRAs: If you’re saving for retirement on your own, you can also find target date funds in an individual retirement account.
- Taxable Brokerage Accounts: While less common, target date funds can also be found in brokerage accounts. However, keep in mind that there may be tax implications with these funds when they are rebalanced over time. The good news is that this doesn’t apply if the funds are held in a tax-advantaged retirement account.
Are Target Date Funds Worth Considering?
For many people, target date funds offer a convenient, low-maintenance way to save for retirement. They automatically adjust to become more conservative as you near retirement age, which means you don’t have to worry about constantly rebalancing your portfolio. It’s an ideal option if you prefer a hands-off approach and want to stay on track with your retirement goals.
However, they’re not without their considerations. While these funds are designed to adjust over time, the exact asset allocation might not align perfectly with your individual risk tolerance. Some people might feel comfortable with a more aggressive investment strategy, while others may want an even more conservative approach. This is where talking to a CERTIFIED FINANCIAL PLANNER™ can help, as they can provide personalized guidance based on your unique financial situation.
How Can a CERTIFIED FINANCIAL PLANNER™ Help You with Target Date Funds?
If you’re thinking about incorporating a target date fund into your retirement strategy, working with a CFP® can be beneficial. A CERTIFIED FINANCIAL PLANNER™ can:
- Help you choose the right target date fund based on your retirement timeline and risk tolerance.
- Provide guidance on how to balance your retirement savings with other financial goals.
- Address any concerns about taxes or rebalancing if you hold target date funds in taxable accounts.
Having professional advice can make sure your retirement strategy is on track and tailored to your needs.