Target-date funds are considered a simple solution for retirement savers looking to invest with a hands-off approach.
Target-date funds have become popular with 401(k) plan investors. Instead of having to choose a number of investments to create a portfolio that will help them reach their retirement goals, investors simply choose a single fund designed to help them reach that goal.
Funds using this investment strategy, also called life-cycle funds and age-based funds, allocate a high proportion of assets to equities during the early years and gradually shift to more conservative assets, such as bonds and bills, as the target date draws near.
A target-date fund operates under an asset-allocation formula that assumes you will retire in a certain year. It adjusts its asset-allocation model as it gets closer to that year. The target year is identified in the name of the fund. For example, an older person who plans to retire in or near 2025 would pick a fund with 2025 in its name. Meanwhile, a younger worker, hoping to retire in 2050, would choose a target-date 2050 fund.
Target-date funds have been criticized for not being customized or tailored to individual situations. To that point, target-date funds do not take into account the individual risk tolerance of any particular investor or any investor's individual circumstances, including any holdings of other assets. Therefore, investors in target-date funds should be aware of how a particular fund intends to reach its investment objectives and what risks that fund's strategies might entail, just as they would with any other investments.
Industry experts agree that even investors who use these funds correctly as their sole retirement investment vehicles need to pay close attention to the strategy. It's important to verify that the asset allocation of investments in a target-date retirement fund changes as the target date nears.
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As with any investment, target-date funds can lose money. The mix of assets in a target-date fund is intended to diminish the risk of loss, but as demonstrated by market events in 2008, stocks, bonds and other assets in a target-date fund's portfolio may sometimes lose value.
Certified financial planner Diahann Lassus, president and chief investment officer of wealth-management firm Lassus Wherley, explains the pros and cons of these funds.