Target Date Funds
Target date funds make asset allocation easy by creating the investment mix and investment choices automatically. These funds are created by mutual fund companies or other managers and are made up of funds picked to match a specific allocation. The fund names usually indicate the time frame or the risk tolerance they're oriented to.
What They Are
Some target date funds are based on a time frame. Examples of these are Fidelity Investments' Freedom funds. As the name designates, the Fidelity Freedom 2015 fund is meant to provide an asset allocation and mix of Fidelity mutual funds that would be appropriate for an investor retiring around 2015. Fidelity decides on the asset allocation and picks the funds to match. As 2015 approaches, the asset allocation is automatically modified to reflect the shorter time frame.
Other target date funds suggest an allocation based on a risk tolerance. These funds feature names with words such as “aggressive,” “moderate,” or “conservative” to show which risk tolerance they are targeting. Vanguard Investments' LifeStrategy funds are examples of these funds. For example, Vanguard LifeStrategy Moderate Growth fund means to provide a portfolio for an investor with a moderate growth risk tolerance.
Target date funds sound effortless, but you still need to research them before you invest. Check to see if there are additional fees created by the so-called fund-of-funds structure of target date funds. If there are, it may be better to pick individual mutual funds yourself outside of the target date fund. Compare asset allocations among fund companies. What the fund company thinks is conservative or appropriate for a 2015 retiree may be dramatically different than the practices of another company. Check independent resources such as
Target date funds make great gifts. Once the minimum initial deposit is met — check the fund prospectus for this amount — even small additional deposits are instantly diversified across all the investments in the fund. A target date fund would be a better gift for a child or student than an individual stock because of the diversification.
Best Times to Use Them
New investors like target date funds because they can be a good way to get started. If you're starting with a small account or a small monthly deposit, the target date fund will offer instant diversification and automatic rebalancing to keep the right asset allocation. Many employers who automatically enroll employees in a company retirement account have started using target date funds because of these advantages. If your employer has done this, check the fund to be sure it's appropriate for you. If you're planning to transfer a large amount of money — from a previous employer's plan or from another account — a target date fund might be the easiest place to start, but might not be the best option for a large amount of money over a long period of time.
