Target-date funds and your retirement strategy
When you joined your workplace retirement program, your employer or the retirement plan administrator might have asked you:
- When do you want to retire?
- How do you want to invest your money?
The first question may be easy for you to answer; the second question might be harder. If you know when you want to retire, a TDF can help you figure out how to invest your money.
A TDF, sometimes called a retirement date fund, is a single fund that’s made up of a variety of other funds. A TDF is meant to be held for the long term—either until you retire or even through your retirement years.
A collection of individual TDFs is called a target-date fund suite. Within a suite, each fund name has a year in it, like 2040 or 2055, and you can choose the fund based on the year closest to the year you plan to start using your money. For each target year, the fund manager does the heavy lifting of portfolio design and construction for you.
Target-date glide paths
Your investment time horizon is the span of time between when you begin saving for retirement to the date you hope to start using the money you have saved. A TDF aims to keep your investment strategy aligned with your investment time horizon by automatically adjusting the portfolio of stocks, bonds, and other assets in the fund.
What does this mean for you?
- If you have a long investment time horizon (i.e., you’re just starting off saving and your retirement date seems very far away), your TDF will be focused on growing your savings. Growth assets like stocks will play a key role.
- As your investment time horizon shortens (i.e., you’re getting closer and closer to your well-earned retirement), your TDF will focus more on protecting your savings. Your investment mix will shift from stocks to more defensive assets like bonds and other income-generating assets.
Your TDF’s investment mix changes to align with your investment time horizon—this is called the glide path. The allocations between growth assets and defensive assets change over time, becoming more conservative as you get closer to retirement.
Asset class layering
The glide path has a mix of assets that are adjusted over your investment time horizon. But it’s not just a simple mix of stocks and bonds. Expert fund managers design the asset mix to include different types of stocks, bonds, and other assets that will form part of the overall mix of assets in the glide path.
Asset classes that your TDF might invest in:
- Equities (stocks)
- Domestic stocks
- Foreign stocks
- Large-cap equities
- Small-cap equities
- Emerging-market stocks
- Dividend-paying stocks
- Fixed income (bonds)
- Domestic fixed income
- Foreign fixed income
- Short-term bonds
- Long-term bonds
- High-yield bonds
- Real estate
Fund managers look for asset classes that will work well together, providing what is called “diversification benefits.” This means that not all the asset classes will move in the same direction at the same time:
- Some asset classes tend to move in the same direction as the broader stock market.
- Other asset classes are more likely to preserve capital when the stock market is going down.
By combining a variety of asset types, the fund manager can achieve the right mix of growth and defensive assets. Here’s an example of how fund managers create layers of investments in a TDF, each with a specific purpose. This asset class mix will shift over time as directed by the glide path.
Generally, the farther you are from wanting to take your money out of your account, the more risk you can take in your investment mix. The idea is that if you have a longer investment time horizon, you have more time to account for ups and downs in the market. You can take on more risks as there’s time for your investments to grow. And as you age and get closer to wanting to take your money out, the more conservative your mix should be to help minimize the chance for loss in value. Over time, the balance in your TDF will shift from core equities to fixed income to derisk your portfolio. Other factors like performance and economic and market conditions are also important.
Understanding underlying investments
Your TDF owns individual funds in the various asset classes. These are the building blocks used to create the asset layering.
In addition to designing the glide path and asset class layering, the fund manager also selects mutual funds, exchange-traded funds, or other kinds of pooled funds to construct their asset class strategy. While the number of underlying funds can vary, they’re chosen based on their style, composition, and how well they work with the other funds in the TDF to provide diversification benefits. TDF managers also typically consider things like performance and fees. All these factors are carefully analyzed when choosing underlying investments as part of a fund.
You can discover what your plan’s offerings are invested in by going to your retirement program website and looking at the fact sheets for the TDFs your plan offers.
Keep it simple with a target-date fund
When you’re saving for retirement, it’s good to understand how the funds in your plan work and to keep up on how your investments are doing. By choosing the TDF that’s in line with your potential retirement year, you get multiple levels of investment help, from the design of a glide path to the selection of underlying funds. Let time and your TDF work for you.
The commentary in this publication is for general information only and should not be considered legal, financial, or tax advice to any party. Individuals should seek the advice of professionals to ensure that any action taken with respect to this information is appropriate to their specific situation.