Asset allocation changes over time for most of us. The mix of investments you have when you’re 25, for example will be different from what you have at 40. Likewise, your investments at 40 will be different from what they are when you’re 55. Specific needs change over time, as does our desired exposure to risk.
This is where target-date funds come into play. You may see them as choices within a 401(k) plan, or within your child’s 529 account. The latter is where I was introduced first-hand to these types of funds, and was presented with these as an option. I didn’t choose to participate then, but recently decided to reevaluate these vehicles and take another look.
What are Target-Date Funds Anyway?
These are funds that are composed of assets within different classes (stocks, bonds, cash, etc), intended to help an investor with asset allocation based on a specific time horizon. The investments within the fund change over time, based on the target date of the fund. Asset allocation and rebalancing is done for you.
For example, if a fund is a 2030 target-date fund, it will probably be weighted more heavily in stocks today than it would be in 2020. As the time to target gets closer, the asset allocation is supposed to be geared toward the use of those funds at that time. Hence, more risk is taken further from the target date, and capital preservation becomes more important closer to the target date.
What do I Like About Target-Date Funds?
- Initial allocation and subsequent rebalancing is done for you. This is a compelling proposition. Instead of having to work on these tasks on your own, it’s taken care of by a professional. Even if you’re smart with money, this may have some appeal.
- They save you time. This is important, as we realize that time is money to a large degree. Having to constantly make sure your asset allocation is appropriate, based on an updated account balance and time to target, can take some time.
- They can leverage scale. Larger funds can use the volume of funds invested to diversify in ways that could go beyond the means of a typical investor
- They’re good for novices. If someone has very little experience and knowledge about investments and the different classes and vehicles available, it makes sense from a risk management perspective. A total amateur could wreak havoc with his or her finances by making ill-informed decisions.
What don’t I Like About Target-Date Funds?
- Potentially infrequent rebalancing. Do they rebalance monthly? Quarterly? Annually? Depending on your preference, considering historical stock returns, these funds may not rebalance enough in increasingly volatile markets.
- May not match with your risk tolerance. We each have our own risk tolerance, and it may or may not match up with that of the fund.
- Might discourage learning. When people take the intellectual curiosity out of the exercise of choosing investments, and leave all decisions to others, it might foster a habit of minimizing time on financial learning. It pays to be dialed in to where your money is going and why it’s to be invested they way it is.
- Limits individual control. That might be a good thing for some, but not for many investors. You might have your own views on different investment vehicles at any one point in time, and more importantly – more specific knowledge of your own personal situation.
As much as I like some of the features of target-date funds, I prefer to have more control. If you have a foundational knowledge of personal finance, and like the feeling of direct control over decisions about your money, you may want to consider what it would be like to turn over these responsibilities to someone else.
On the one hand, this is what we do with mutual funds anyway – at least the non-index fund types. However, when the time horizon comes into play, personal goals and needs create unique circumstances for many of us that may not fit into a one-size fits all solution.
So for me, I choose not to go with target-date funds.
That said, if someone is a novice without a comfortable knowledge of basic investment principles, I think these could be a really good choice. I’m sure there are those that might totally agree, as well as others who might totally disagree with my assessments:)
Questions for You:
Do you own any such funds?
Are you inclined to be able to hand over asset allocation/rebalancing to someone else, or do you feel the need to exert more personal control over the direction of your money?
photo credit: MikeBehnken