In this month's Monthly Financial Jargon series, we address a term that many of us associate with and keep in mind when it comes to retirement accounts and employer-sponsored retirement plans: target-date fund.
What is a Target-Date Fund?
A target-date fund, more commonly referred to as a TDF, is a fund – a professionally managed pool of money – run and offered by an investment company whose goal is to grow the fund’s assets over a specified period of time. Target-date funds are allocated to address their investors’ capital needs at a future – or target – date. Investors typically leverage target-date funds for their retirement accounts and employer-sponsored retirement plans, like a 401(k) or 403(b), or for specialty accounts that hold money intended to be tapped into upon a specified future date or time frame, like a 529 account being used to save for a child’s future college years.
Like any type of investment fund, a TDF comprises capital that belongs to numerous investors used to purchase securities, and all investors of the fund retain ownership of their own shares. One of the primary benefits of an investment fund, like a TDF, is its broad selection of investment options that are selectively evaluated and picked by an experienced fund manager. Fund investors also typically benefit from lower costs and fees than if they were to build and manage a similarly allocated portfolio on their own. One of the main types of investment funds is a mutual fund, and a target-date fund is a type of mutual fund.
The most unique feature of a target-date fund is that it is automatically rebalanced over time by its fund manager according to the fund’s target time horizon. The time horizon reflects the number of years between now and the fund’s future maturity year, the year in which investors anticipate they will begin liquidating the account. In the early years of the fund’s inception, the fund’s allocation is heavier on stocks, and over time, as the fund ages and draws closer to its target maturity date, the fund gravitates to a more conservative allocation that is heavier on bonds. In other words, the asset allocation of a target-date fund becomes more conservative as the fund’s target date nears and investors’ risk tolerances fall. The fund’s portfolio manager creates the fund’s allocation and investment strategy based on the pre-determined time horizon, as the time horizon provides the portfolio manager with the degree of risk the investors are willing to take. Given the nature of target-date funds to grow more conservatively over time, a TDF portfolio manager typically adjusts the risk within the fund’s portfolio annually.
TDFs offer investors a simple and convenient way to invest their money and then leave it – an example of a “do-it-for-me” investing method. The fund manager takes care of the annual reallocations, and investors can simply set their investments on auto-pilot until the time horizon lapses. Target-date funds are aptly named for their time horizons, and these funds are typically considered extremely long-term investments. For example, American Funds has a 2060 Target-Date Fund, meaning the fund currently has a 40-year time horizon. This fund targets investors who are in the early stages of their careers who do not plan to utilize their funds until around the year 2060, when they are at or near retirement.
Final Points
Overall, target-date funds leverage traditional portfolio management strategies to reflect an asset allocation throughout a fund’s term that meet its investment objective. These all-in-one investment vehicles with fully diversified portfolios are invaluable for investors who want to throw their investments on autopilot. However, keep in mind that the investment objective of a TDF will not deviate from the fund’s time horizon, so if your individual investment goals change along the way, you may need to turn off autopilot and evaluate your investments to determine if another investment vehicle would be a better fit.
Monthly Financial Jargon: The world of finance and investments is notorious for its extensive use of jargon. With a goal to enhance financial literacy and make the world of money more transparent, we have our “monthly jargon” articles that focus on debunking financial terms that are often used sans explanation.
Questions and/or interested in how this applies to your financial life?
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