Some people love these so-called "set it and forget it" funds because of the completely hands-off approach to investing they offer. A variety of factors contribute to determining if you should invest in target date funds, but it is most important to first understand what a target date fund is and how it works.
What Is A Target Date Fund?
A target date fund has a calendar year in the name of the fund, such as Target Date Fund 2020, Target Date Fund 2030, and Target Date Fund 2040. Target date means your target retirement date. It doesn't mean you have to retire then — it just means that the date estimates when you think you would retire.
Many 401(k) plans offer them as one of the investment choices. The investments inside a target date fund are being professionally managed to meet the needs of someone planning to retire near the calendar year that appears in the name of the fund. The investments are also being changed so that as you get closer to the retirement target date, you are invested more conservatively.
Why Should I Use It?
Target date funds are designed to offer one-stop shopping. First, you pick a fund that has a target date that is closest to the year in which you think you will retire. Then, you put all your money into that fund confidently because the fund is not a single investment.
Instead, it owns lots of investments put together in a strategic way. It is designed to create a diversified portfolio for you, and the fund automatically makes appropriate changes to your asset allocation so you are invested more conservatively as you near retirement.
People Don’t Use Target Date Funds Correctly
Target date funds are a great choice to get professional money management at a very low cost. However, most 401(k) plan participants don’t understand target date funds. For example, you do not need other investments with target date funds.
Target date funds spread your money out over numerous different asset classes, usually by owning other mutual funds. Even though it is one fund, it offers all the diversification the average person would need.
Target Date Fund Advantage
The key benefit of using a target date fund is that you do not have to pick ten different funds in the right proportion because the fund is doing this for you. The investments are chosen to provide the probability of a good outcome for someone retiring near the calendar year that is in the name of the fund.