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Target-Date Mutual Funds: The Basics

Target-Date Mutual Funds: The Basics

One of the more recent popular innovations in the mutual fund industry has been the creation of target-date mutual funds. Instead of burdening the investor with portfolio rebalancing throughout time (investor’s typically desire to take less risk as they age), the target-date fund systematically adjusts the portfolio to become less risky over time.

While target-date funds were created in the 1990s, they have only recently started to gain traction with a large number of investors. These funds, also called lifecycle funds, are managed according to an assumed retirement date. For example, if you plan on retiring around 2035, you could invest in the Fidelity Freedom 2035 Fund, which currently holds about 60% US equities, 22% International Equities, and 18% Bonds. As the retirement date gets closer, the portfolio automatically rebalances to include more bonds and income-generating type funds, such as the Fidelity Freedom 2015 Fund, which invests only 50% of the portfolio in US and International Equities, 40% in bonds, and 10% in short-term funds.

Advantages

The simple advantage of an automatically rebalancing portfolio is a big selling point for many investors—big enough so that Fidelity manages $20 billion in its 2020 portfolio alone. Each fund provides detail showing exactly how the portfolio will rebalance throughout the years, so that along with not having to worry about rebalancing the portfolio yourself, you will know ahead of time what your allocations will be and can use that in planning your financial future.

Disadvantages

One of the biggest disadvantages with target-date funds is that they are relatively new and have investment horizons that stretch out for decades, so we cannot yet tell if these funds will meet their stated objectives. For example, we will not know if the 2040 funds end up being the right choice because the time horizon is so far away.

Also, it is important to realize that different mutual fund companies have different asset weightings; the Fidelity Freedom 2015 example above notes a 50% allocation to equities, while the Vanguard Target Retirement 2015 Fund allocates 58% to equities and the rest to bonds, with no specific allocation to short-term funds. By forcing you to rebalance your portfolio, you are also not in control of your investments and are just lumped in with the entire portfolio, which ignores your specific risk and return objectives, i.e., you may want to be more or less conservative than the fund allows.

Target-date funds can help the average investor by setting an asset rebalancing strategy on autopilot; however, they may not be appropriate in all situations. Before assuming that a target-date fund is right for you because of the retirement date, check its allocations to see if they match up with your desired portfolio. By understanding how these types of funds are managed, you will be able to make better, more informed decisions with your portfolio.

 

 

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