Taking a Look at Target-Date Funds

What Is a Target-Date Fund?

Target-date funds have withstood an extremely volatile 2020. These investment plans, also called life-cycle funds or age-based funds, are designed for people who want a simple, hands-off way to invest for the long-term. Usually people use target-date funds to save for retirement, but they can also be a helpful way to prepare for other significant financial events like a child starting college.

A target-date fund rebalances over time. This means that early in a target-date fund’s lifecycle, assets are put in higher-risk investments, like stocks. As time passes, money is gradually transferred to lower-risk investments, like bonds. Essentially, investors can pick a “target date” when they want to cash out, and their investment becomes gradually more conservative as that date draws closer.

Pros and Cons of Target-Date Funds

Because they have gained popularity recently, the pandemic-related economic fallout was an important test for target-date funds. Most analysts feel that they have weathered recent economic volatility relatively well.

For example, when US stocks tumbled 34% between February 20 and March 23 as the coronavirus pandemic set in, target-date funds analyzed by Morningstar only declined by an average of 10%. Target-date funds aiming for 2060 or further in the future fell an average of 20.7%, but these funds have 40 years or more to recover, and the money in them will be transferred to lower-risk investments as time passes.

Like any investment, target-date funds have advantages and disadvantages. These funds are a low-effort way to have a diversified portfolio. For many people, the low-stress nature of target-date funds is very attractive.

On the other hand, target-funds are inflexible. If a person decides to retire earlier or later than expected, a target-date fund will not adjust with their changing needs. Though they are meant to protect people’s money as time passes, target-funds can still underperform—and, like any investment, they are not completely risk-free.

What to Keep in Mind When Choosing Target-Date Funds

There are many different types of target-date funds. For example, all 2045 target-dated funds will put money into equities, but some might favor domestic stocks and others might look to international stocks. During the later part of a target-date fund’s lifecycle, some may put money into investment-grade bonds while others will opt for high-yield, lower-grade debt investments.

Before investing in a target-date fund, it’s worth doing some research about where money will be going throughout the course of the fund’s lifecycle. Examining how different target-funds have fared during the recent economic downturn can be a helpful way to predict what may happen to target-funds in case of economic volatility down the road.

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