Target date funds (also called lifecycle funds) are mutual funds that link an investment portfolio to a particular time horizon. In fact, most target date funds have a date attached to their name. This date should be correlated with a particular event in the investor’s life, most usually their expected retirement date. These funds are becoming more and more common in company 401(k) plans.
Target date funds are unique in that they are actually fund of funds, meaning the target date fund invests in a collection of mutual funds. This is done for diversification purposes. For instance, a target date fund will usually be made up of mutual funds that specialize in large, mid, and small cap stocks, international stocks, and even corporate and government bond funds. As a fund of funds, a target date’s expense ratio is heavily impacted by the expense ratios of the underlying funds.
Target date funds are designed to automatically scale back the level of investment risk in a portfolio as the investor ages. Young investors, not intending to retire until 2040, probably prefer to be aggressive while retirement is not on the horizon, but become more and more conservative as retirement approaches. Target date funds accomplish this goal automatically. As the date gets closer to the target date, the fund will usually begin selling stocks and purchasing bonds and money market instruments, making the portfolio continually more conservative.
It should be noted that a fund does not cease to exist when the target date is reached. The fund of funds will continue to operate as usual after reaching the target date. That date simply measures how aggressive or conservative the fund should be at any point in time.
Before investing in a target date fund, be aware of the implications of using a “one-size fits all” approach to investing. The target date fund may not scale back the aggressiveness of a portfolio as quickly as some investors would like, while being too conservative for others. This is a serious issue not present when an individual utilizes a portfolio of individual stocks, bonds, or mutual funds where they have more control over the portfolio’s overall level of risk.
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