This blog contains some simple tips and advice from two regular guys. We're not accountants, financial advisors, or brokers, so follow, ignore, or discuss our ideas as you see fit.

Friday, November 16, 2007

What Is A Target Date Retirement Fund?

Posted By Paul

A fairly new feature on the mutual fund landscape is a create called the 'Target Date Retirement Fund'.

What is it? Well the idea behind it is that if you're investing for retirement you should invest in more aggressive and risky investments when retirement is far off, but as you approach retirement you should start to move your money into more conservative funds so that a sudden drop in the market doesn't hurt your nest egg right when you need to start using it.

Generally what people do is something where in their 20's and 30's they focus on the more aggressive mutual funds, then in their 40's they move into the more moderately aggressive funds, and then as people start to approach retirement age they move into the less risky funds.

If it's such a simple process then why can't it be done for you? Well that's what a Target Date Retirement Fund is. So let's say you plan to retire in 30 years, then the idea is that you could buy a Target Date Retirement fund that is targeted to that timeline (these sorts of funds generally have names like 'Target Retirement in 2035') then sit back and let the fund manager handle allocating your investments and gradually transitioning it to more conservative investments as time goes on.

I am intrigued by this idea since it seems about as close to a 'set it and forget it' fund as possible. In fact one of our Roth IRA's is in a Target Date Retirement Fund. If nothing else it seems like a simple place to put your money until you decide if you want to put it elsewhere.

One thing I have read that you need to be careful about is to not take too much advantage of the 'set it and forget it' mentality. Specifically if you have such a fund, check it periodically to see where the investments are. Perhaps the fund managers opinion of 'acceptable risk' when your 10 years away from retirement is different from yours.

A nice thing with these funds is the fact that you can change your risk levels by changing funds. For example, let's say that you plan to retire in 30 years so you put your money into a 'Target Retirement in 2040' fund. You then decide that this fund has more risk in it than you'd prefer, and you're willing to give up potential returns in favor of less fluctuations in your fund. You can move some or all of that money instead into a 'Target Retirement in 2035' fund. The fund manager doesn't care if you actually plan to retire by the target date or not, and by making this move you've transitioned your investments further along in the transition from aggressive to conservative.

I am quite new to Target Date Retirement Funds but I think I'm going to look into them more closely. My hope is that I can use these Target Date funds to create a gradual transition from risky to conservative investments while also moving between funds to fine-tune the risk tolerance more closely.

1 comment:

CT said...

Target Retirement funds are great if you want to do absolutely no thinking about how you want your retirement savings to be invested, but if you are going to be moving money between funds I think you will run into less headaches if you do it yourself.

Most of the target date funds I've seen just own a few different stock market index funds and a bond fund, changing the allocation between the funds as time goes on (basically from less bonds to more bonds). That's not a bad strategy, but you don't really have any idea what changes the fund manager will make over time, and the strategy is so simple that you can learn it in two minutes and do it yourself.

Personally, I have a half-dozen different index funds that I own in different percentages, and I add money to and rebalance my portfolio every month. I'm investing long term and not trying to time the markets, but setting my own asset allocation gives me more flexibility than a cookie-cutter retirement fund. For example, I have some of my funds in a commodity index and some in a REIT index, which normally aren't included in a standard equities/bonds mixed fund. Overall I think I have better deversification and more control over my risk, without having to pay any more in expenses or trading fees.