Should you invest for retirement by using target date funds? Good question, and it’s one that each person our couple should answer for themselves based on an assessment of the pros and cons of target date funds. Like many of other decisions when it comes to money and relationships, this could be one where people see it differently and might need to compromise.
Background on Target Date Funds
First off, before compromising on anything, let’s take a look at what target date funds actually are. These are funds that basically take care of asset allocation over time for an investor with a specific time horizon. They theoretically do much of the work for the investor, at least that’s how I’d describe the concept. Instead of the investor needing to continually rebalance and work on asset allocation, particularly in light of risks and need for return and how this changes over time.
For example, someone retiring in 30 years might want to invest now in stocks more so than other lower risk, lower return vehicles. Thus, a target date fund might be more heavily weighted toward stocks early on.
When that person gets to the point of being just 5 years to retirement, the aggressiveness of the portfolio would be toned down. There comes a point when capital preservation starts to get more important. Being just 5 years from retirement would seem to be a time, for many people, when they would not want to take on excess risk just for the potential of high growth. Rather, you want to make sure you have something there when you need it soon!
Keeping that in mind, let’s take a look at target date funds and some of the pros and cons of each.
Pros of Target Date Funds
- Save the investor time. Depending on how often you want to rebalance, it can take some time to do rebalancing on your own. Not much time, most likely, but there is effort necessary. With target date funds, it’s done by the pros.
- Good for those uncomfortable with investing. If someone really doesn’t know much about investing, this might be an appealing option. A person without much confidence in his or her own knowledge could end up causing damage to retirement prospects with the wrong moves.
- Take advantage of scale. There is something to be said for being able to take advantage of massive amounts of investor money for the good of the group. By using scale, funds can find opportunities to diversify investments for individual investors that those people might have trouble replicating.
Cons of Target Date Funds
- Less control for the investor. With target date funds, the moves are generally made without direct investor control. While that might be a good thing for some people, as we alluded to earlier, that might not be so appealing for others.
- Less turnover. This might be an issue, depending on how often a fund makes changes. In volatile markets, do you want to wait one year for anything to change with rebalancing?
- May not match the risk preferences of the investor. Your risk tolerance might not match up well with that of what the fund has.
Bottom Line: Much like any other decisions a couple might face, sometimes there isn’t a universally right or wrong approach to choosing certain styles of investing. It’s good to have a sense of your own goals and level of knowledge, and make decisions that are informed. Getting a sense of the pros and cons could help steer you one way or the other.
What do you think?
What do you think about target date funds for retirement?
Do you prefer to have full control, or do you find the benefits of these funds to be worth it to you?