Does investing seem overwhelming at times? After all, this process involves researching, selecting, selling, and even rebalancing various options. Luckily, there are investments that could make saving for long-term goals such as retirement simple: target date funds.
Target date funds invest in different funds that have exposure to stocks and bonds, which rebalance over time. Initially, they’re weighted to riskier, but higher reward, assets like stocks and gradually shift towards more conservative investments like bonds. This comprehensive guide will cover the fundamentals of these investments along with traits of the best target date funds.
Target date funds automatically structure an investor’s asset allocation for certain goals based on the time horizon. For example, funds that have 2055 in their names are used by younger investors that want to retire in or close to that year. Others might have shorter time horizons like 2030, which can be used by workers that want to retire earlier.
These investments are primarily used to save for retirement and are common in employer-sponsored plans like 401(k)s and 403(b)s. They are considered “funds of funds” meaning that their holdings are mutual funds, index funds and/or ETFs. For instance, the Vanguard Target Retirement 2055 (VFFVX), has exposure to index funds like the Vanguard Total Stock Market Index (VTSMX) and the Vanguard Total Bond Market II Index (VTBIX).
One common mistake investors make is to have multiple target date funds in their investment accounts. They aren’t designed to work like that as the one fund will adjust your asset allocation as you approach your expected retirement year.
It’s also important to not complement these funds with other investments like ETFs, index funds, or mutual funds. Each fund is designed to be the sole investment in your account.
Having multiple investments in addition to your target-date fund will also increase redundancy. For instance, some target-date funds might already have exposure to the ETF you’d like to add!
These tools diversify your assets, which protects you from market risk. They invest in funds that have exposure to US stocks, corporate bonds, international stocks, municipal bonds, real estate, and more.
You won’t need to constantly manage or rebalance your investments. Target dates do this for you since they adjust asset class weightings as you age. This saves you time and stress that might come from active investing strategies like picking individual stocks.
Many investments including index funds might have investment minimums that could start at $2,000+. Luckily, most target dates have low, or no, minimums. This makes them a viable choice for investors that have little capital and for those that have access to their employer’s 401(k) or 403(b) plan.
Target date funds are simple, but they can have high fees. For example, Fidelity’s Freedom® 2065 Fund (FFSFX), has an expense ratio of 0.75%. This is relatively high as many actively managed mutual funds have expense ratios of 1%+.
Conversely, index funds and ETFs can have expense ratios of 0.10% or less! These investments have high fees because they have exposure to several funds and have to account for potential mutual fund manager fees. It could make more sense to simply buy a few stock and bond ETFs for a fraction of the price.
These investments make it easy to adjust your asset allocation, but they come with a cost. They’re much harder to customize than other investments. It’s harder to tailor your portfolio if you want to retire a decade earlier or later than your target date fund’s retirement date.
Target date funds might be diversified among different asset classes. Yet, they might have a significant overlap among portfolio management strategies. Many target-date funds only invest in mutual funds, index funds, or ETFs offered by the same company.
Turnover refers to how frequently a fund buys and sells investments. The best target-date funds have low turnover, which produces fewer capital gains taxes. However, you can avoid capital gains taxes if you hold these investments in an IRA, Roth IRA, 401(k), or 403(b) plan.
Some of the best target-date funds like Charles Schwab’s Target 2055 Index Fund,
SWYJX holds low-cost index funds. This particular fund has an expense ratio of just 0.08%. Like most target-date funds, it has no loads (sales commission) and no minimum investment requirements.
Companies offer dividends or extra payments to investors, which motivates them to keep or even increase their investment in that stock. Target date funds that hold stock (equity) funds can pay dividends on a quarterly or semi-annual basis. These yields usually range from 2-3%.
These can be seen as either the Trailing Twelve Month (TTM) or SEC yield. The TTM yield refers to the percentage that was paid over the last 12 months, while the SEC yield is the most current one as of the prior month. Dividends might not seem like much, but they can significantly grow your wealth due to the power of compound interest.
Investing might seem daunting at times since it involves many tasks like research and rebalancing. Fortunately, target date funds are simple tools that automate these investing activities. They can be used to invest for long and short term goals, which can be seen by the fund’s year.
Knowing the fundamentals of these investments along with the characteristics of the best target date funds will help you build long-term wealth.
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