Portfolio rebalancing comes with the territory. Rebalancing your investment portfolio on a regular basis allows you to manage risk and realign your investments to stay on track toward your goals. 

Investing in target-date funds is an alternative for investors who do not wish to do their own rebalancing but are interested in a broadly diversified portfolio for retirement savings. The glide path of a target-date fund will automatically rebalance the fund over time. This is what makes the fund so appealing.

How target-date funds work

A glide path shows how the asset mix of a specific target-date fund will change over time as an investor approaches retirement. An investor’s portfolio evolves over time from heavily weighted stocks to a mix that is predominantly bonds and eventually short-term reserves.

Risk is inherent in all investments. Investments in target-date funds are subject to the risks of their underlying funds. The year in the fund name refers to the approximate year (the target date) when an investor in the fund would retire and leave the workforce. As the fund approaches its target date, it will shift from more aggressive to more conservative investments. 

But nothing is ever quite as simple as it seems. A target-date fund investment cannot be guaranteed, even after the target date. Investments in bond funds are subject to interest rate, credit, and inflation risk. Diversification does not ensure a profit or protect against a loss in a declining market.

Let’s walk through the pros and cons of target-date funds.

Advantages of target-date funds

You can choose between two types of target-date funds: target date and target risk.

Ease of choice

Target-date funds use an asset allocation formula that assumes you will retire in a certain year and adjusts the asset allocation model as the date gets closer to retirement. The target year is identified in the name of the fund. 

With target-risk funds, you generally have three groups to choose from. Each group is based on your risk tolerance: conservative, moderate, or aggressive. If you later decide that your risk tolerance has or needs to change as you get closer to retirement, you have the option of switching to a different risk level.

Diverse options

Target retirement funds offer a variety of investment options. There are funds that provide active management, passive management, exposure to a variety of markets, as well as a selection of asset allocation options. Investors who are willing to do some research will likely find a fund that works for them.

Disadvantages of target-date funds

There are downsides of target-date funds to consider before investing. It’s not simply a “set it and forget it” solution. Finding a fund with the right date is just the beginning of the decision process.

Not all funds are the same

Contents of the funds with the same target date can vary greatly, and proportions can vary even more over time. Additionally, target-date funds don’t automatically adjust to changes in your life. If a major life event impacts your finances or alters your retirement date, you may need to move your money to a fund with a new target date or change your asset mix to one that’s more aggressive to make up for money you might withdraw early.

Funds can also differ in terms of investment style. For example, you can find a fund that is made up entirely of index funds. Based on algorithms, such a fund is likely to have lower fees. But investors who prefer active management would need to choose a different type of fund. 

Expenses

Target date funds may charge management fees that are above average compared to other mutual funds. They are generally more expensive than index funds.

All mutual funds charge expense ratios — the fees that compensate the fund managers and pay other expenses. As funds of funds, each target date fund buys many other funds, meaning you are charged expense ratios for the target date fund and each of the funds it purchases.

Choosing a target-date fund is one thing, but correctly implementing your retirement savings strategy is another thing altogether. If you need guidance on determining the right investment strategy for you, give us a call today.