Target Date Funds (TDFs) are designed as a “one-stop-shop” for your retirement assets. By investing in a TDF, you choose a fund whose number corresponds to your expected retirement year. This fund has a predefined asset allocation that adjusts automatically as you approach retirement. However, selecting a fund should not be based solely on your time horizon. Your investment decisions should also consider your financial goals and risk tolerance. Target Date Funds typically assume that your primary goal is retirement, which may not be suitable if you have other financial objectives. Moreover, these funds do not account for individual risk tolerance, which is an essential factor in investment strategy.
TDFs simplify investing but are subject to real market risk, including significant losses during bear markets. While they tend to lose less during bear markets, they also gain less during bull markets, making them less volatile and advertised as less risky.
TDFs allocate proportions of each equity fund based on their market value. These equity funds are diversified geographically across the developed world on a value-weighted basis. This geographic diversification results in an underweighting of global technology compared to holding only U.S. equity funds.
Report Characteristics and Performance of Target Date Funds in the United States:
we encountered large differences among TDFs. Funds with the same target year varied widely in their risk tolerance, and risk adjusted rates of return varied substantially — the difference between the 90th and the 10th percentile was on the order of 2%-4% per year, and larger than that in some years.
TDFs with the same target year have may have different glide paths, so research your fund’s glide path. E.g., for Vanguard, the glide path doesn’t level off until target year plus 7. T.RowePrice funds can have 97% in TDFs 25+ years from retirement, and 60% in TDFs 5 years from retirement.
This is also the problem with the “take 100/110/120 minus your age to determine your bond allocation” statements — they only look at your age, and ignore everything else (including the risk of bonds).
TDFs typically comprise four index funds:
While less customized, a target date fund represents a superior alternative to non-participation. If the choice is between a target date fund and remaining entirely in cash, electing the fund is mathematically preferable. Morningstar lists many available TDFs with basic analysis. Despite a lack of flexibility, target date funds are simple to implement, typically have low fees, and automatically reallocate as you age.
Super-simple strategy for taxable accounts:
You must thoroughly understand the composition and glidepath of any target date fund in your portfolio. Typically, equity exposure begins to decrease 25 years prior to the target date and stabilizes seven years post-retirement (see Figure 11.6). Upon reaching the target date, the fund transitions into a retirement income strategy, modifying its asset mix. Review the fund prospectus to verify these parameters.
Buy the underlying index funds separately if you prefer to manage your own glidepath.