- Target date funds are an easy way to get a diversified set of investments that are managed by professionals and adjust to your need date automatically.
- Target date INDEX funds are the least expensive of your choices.
When you are new to investing there is a huge learning curve before you can properly manage your own portfolio. A Target Date Fund is an all-in-one solution to get a balanced and diversified portfolio with just one decision. There are good and bad Target Date Funds, so keep reading.
If you were going to manage your own portfolio without the help of a Target Date Fund, your plan of action would look something like this:
- Learn about the major investment categories: small-, medium-, and large-cap U.S. stocks, international stock, corporate bonds, governments bonds, and real estate investments trusts. Learn about index funds.
- Decide on your investment objectives and your personal risk tolerance.
- Choose an asset allocation that fits your goals.
- Choose mutual funds, ETFs and other investments that fulfill your asset allocation.
- Check your allocations once or twice a year and rebalance.
- Gradually shift it to a less risky mix as you approach the date you want to withdraw the money.
Obviously, that is a lot of work. You could pay a financial advisor to manage your portfolio and they would charge you at least 1% of assets under management (AUM). Or you could achieve something similar with a robo-advisor who will charge you 0.5% of AUM.
Target Date Funds are a way to get a similar set of professional management services and pay less in fees. They use the same process of choosing an asset allocation, choosing investments, rebalancing regularly, and shifting to less risk as your need date approaches.
You choose a specific Target Date Fund by deciding what year you will need to access the money. For example, if you plan to retire in 40 years, which would be the year 2065, you could choose a Target Date Fund with 2065 in the name.
Warning: There are some bad target date funds that charge a very high “expense ratio” (management fee) so always check the fees.
The following fund families have consistently low fees and are built with Index Funds, which is how a new investor would likely build their own portfolio from scratch.
- Fidelity Freedom Index 20xx Fund Investor (expense ratio 0.12%)
- Schwab Target 20xx Index Fund (expense ratio 0.08%)
- Vanguard Target Retirement 20xx Fund (expense ratio 0.08%)
A Target Date Fund is a great start, but not the end of your investment journey. As you learn more about investing, you can choose other investments. The one-size-fits-all approach might not meet your needs in the future and you can shift money out of the Target Date Fund at that time. You are not locked in forever. It is an excellent place to get a low cost, low maintenance, quick start on investing with a small initial investment.
