A target-date retirement fund is a mutual fund composed an asset class mix that changes in allocation over time so the fund becomes more conservative as the investor approaches retirement. Many people are attracted to target-date retirement funds, also known as life-cycle funds or age-based funds, for their set-it-and-forget-it ease of management. They just select one mutual fund and keep contributing money to that fund without every having to worry about rebalancing or adjusting their allocation.
Investors are supposed to select a target-date fund that corresponds with the year of their expected retirement. For example, if the investor plans to retire in 2035, the investor selects a target-date fund intended for individuals retiring in 2035. The target-date fund will invest in a mix of stocks, bonds, and cash equivalents, and the allocation to each will depend on the number of years until the target-date is reached. For example, a target-date fund might hold 80% stocks and 20% bonds when the target date is 25 years away, but as the target date approaches, the target-date fund will decrease the allocation to stocks and increase the allocation to bonds, making the fund allocation more conservative. The allocation to each asset class and the transition rate to a more conservative allocation can vary greatly among the different target-date retirement funds at different mutual fund companies. This can make target-date funds extremely difficult for investors to evaluate, compare, and select among the many target-date funds available.
When selecting a target-date or life-cycle fund, people should evaluate their time horizon and their risk tolerance. A target-date fund considers an investor’s time horizon but may not account for the investor’s risk tolerance. This oversight can cause stress for owners of target-date funds. A conservative investor may be able to tolerate the volatility of a target-date fund when he is 25 years from retirement, but if the fund does not transition to a conservative allocation as quickly as he would like, then the investor may be dissatisfied with the volatility of the target-date fund when he is just 5 years from retirement. On the other hand, an aggressive investor may select a target-date fund that matches her expected date of retirement, but if the fund allocation is more conservative than her risk tolerance, then she may be dissatisfied with the fund’s lagging performance over time.
This one-size-fits-all approach is a significant drawback to target-date funds. Investors can select a target-date fund that matches their expected retirement date, but beyond that, they have little control. Target-date fund investors cannot dictate which asset classes they want to own or when they want to change the allocation. However, that is the purpose of target-date funds. People who select target-date funds would rather have a mutual fund manager make those decisions. Target-date retirement funds can be a suitable investment as long as people understand their limitations and agree with the mutual fund’s strategy. Target-date funds are not the one-size-fits-all way to save for retirement, but for those people who are comfortable with the set-it-and-forget-it investment strategy, target-date funds may serve as an acceptable autopilot.
