Asset allocation is an extremely important lever controlling your investment risk and returns. Knowing how much risk you should have at each stage in your life will help you invest effectively, without chancing losing it all. To assist with this asset allocation, a type of fund called “Target Date Fund” were created.
What is a target date fund?
Target date funds are portfolios of investments that are managed on the basis of risk. The idea behind these funds is that you select a date in the future, usually when you plan on retiring. The fund will then handle the asset allocation for you, gradually shifting from a stock-heavy weighting at the onset to a more balanced or fixed income heavy weighting at your target date.
Alright, target date funds do the asset allocation part of investing for me. Surely it’s not that simple?
What other factors impact target date funds?
Not all funds are created equal. While the premise is the same, some target date funds will target different areas of stocks. For example, one fund may invest more heavily in natural resource companies stocks, while yet another fund focuses more on financial companies stocks. Each fund is trying to out-do other funds, while maintaining the asset allocation risk levels based on your target date.
Even the risk level can vary by a few percentage points across different funds. For example, several funds with a target date of 2045 may have different levels of stocks. Some funds might have only 85% stocks in the portfolio, and yet others may go as high as 92% of stocks. This could have significant impacts on both the risk and return of the fund.
When investing in target date funds, research is required to make sure that you are investing in a fund that aligns with both your social and financial goals.
What happens when the Target Date is reached?
Target date funds are usually used for long term investing. The target date is not the end of the fund, but rather the end of when you are expected to be contributing to the fund. After that date, it is expected that you will be withdrawing from the fund, as in the case of retirement. This means that the monies in the fund will be more heavily weighted in fixed income and cash, providing you marginal returns while reducing risk.
Once again, this is a general case. Some funds do actually force a “liquidation” of sorts, and convert your target date fund into a different, more conservative portfolio. When picking a target date fund, this is an important question to ask; “What happens on the target date?”
Target Date Funds provide a relatively straight-forward way to invest in a diversified portfolio, while also ensuring an appropriate asset allocation strategy is being followed. The fund will reduce risk as you approach the target date, ensuring that your long term investments will be better protected against market fluctuations when you expect to draw on those investments.
As with all investment decisions, research and counsel from a financial planner is advised. But the most important element is that you take action and invest now, as soon as possible.
Financial freedom is a goal of all of us, and target date funds provide an easy way to step into the world of investing with a reasonably good strategy right out of the pamphlet. Investing in your future is the only way to ensure that future meets your dreams. While the world of investing sometimes seems complicated, target date funds might just be the answer you were looking for!