What is a “Target Date Fund”?
Target date funds are structured as mutual funds or ETFs (exchange-traded funds) and their portfolio is designed to grow investors’ assets in an optimized risk-return fashion over a specific time horizon. As their name suggests, the investor is expected to require some of the funds at a future date, which is the “target date”. Typically, that could be a retirement, a future expense – for example, payment for children’s university fees, or a personal event such as a wedding. Target date funds are ready-made multi-asset portfolios that in the case of active funds are run by a professional manager. They make all the heavy lifting and ongoing management work on behalf of the investor.
Key Learning Points
- Target date funds could be active or passive, structured as a mutual fund or an ETF
- They aim to optimize risk-adjusted returns for a pre-set time frame by regularly rebalancing the asset class mix in the portfolio
- The asset allocation is designed to gradually reduce the risk in the portfolio when the target date approaches – usually by increasing exposure to more conservative, liquid asset classes
- Target date funds are an excellent option for investors who want to invest without dedicating a lot of time and effort while benefiting from professional management
How do Target Date Funds work?
In order to achieve the return objective, which is contained in the name of the fund (for example Legal & General Target Retirement 2050), target date funds employ a traditional asset allocation approach. Typically, they would have a long time horizon, which allows flexibility to change the allocation in accordance with the target. During the early days after the fund’s launch, the portfolio is expected to exhibit higher risk and be overweight in asset classes such as equities. A gradual shift towards more conservative areas such as bonds or money markets can be expected when the specified date approaches.
Depending on how the fund is structured, some products may offer ongoing management beyond the target date. Some funds will cease any adjustments to the portfolio after this and others would continue to run it after that specific date.
Advantages and Disadvantages
One of the major benefits of investing in target-date products is that investors can align their personal goals and plans with a future date. It is effective and can be done without needing to build asset allocation models, optimize the portfolio, select underlying constituents and manage risk. This is a ‘set and forgets approach and due to its multi-asset nature, investors can gain exposure to a range of asset classes, sectors and investment styles.
Diversification is another feature that ties with target-date funds – it helps investors navigate through various periods of market stress and different market cycles. Considering increased life expectancy, investors are likely to face a larger number of market downturns. Therefore, investing toward a specific date for the long-term might be best achieved by investing in such strategies.
The main drawback of these funds is their pricing structure. Their management fees tend to be higher than those of mutual funds, but investors should be aware that this is partly due to the charges applied by the underlying constituents (funds).