Target date mutual funds take the hard work out of building a diversified portfolio. And judging by their soaring popularity, investors appreciate the convenience.
Target date funds, also known as lifecycle funds, assemble different asset classes into a single portfolio with weights geared to a specific year in the future.
Target date funds, TDF, are most frequently used for retirement savings in 401(k) plans and IRAs with the target date being an investor’s expected retirement year.
The TDF structure is also used for 529 college-savings plans with the target date being a student’s college enrollment year. Fund managers handle asset allocation and rebalancing, shifting gradually from a growth objective to one focused on capital preservation and income.
TDF funds continue to attract new investors. Assets in such funds reached $334 billion in 2010, an increase of 82 percent over the last three years, according to Financial Research Corp. Among 401(k) participants, 33 percent now own a target date fund. And for college savers, 35 percent of 529 plans sold through financial advisors use target date or age-based portfolios.
Using TDFs effectively gives you the best chance of reaching your long-term goals. But before putting your savings on cruise control, take stock of these four common mistakes that can derail a target date approach.
1. Choosing the wrong glide path
Not doing your homework is the most common and curable error for target date investors. You should know that the target date is the year when you’re expected to shift from saving to spending. You’ll also want to study the glide path, the manager’s plan for shifting a fund’s allocation over time from mostly stocks to less risky assets.