-
A target date is the approximate year when investors plan to retire or start withdrawing their money. The principal value of the investment is not guaranteed at any time, including at the target date.
Each target-date portfolio seeks the highest total return according to a preset asset mix. Over time, the asset mix and weightings are adjusted to be more conservative. In general, as the target year approaches, the portfolio's allocation becomes more conservative by decreasing the allocation to stocks and increasing the allocation to bonds and cash equivalents.
Broad Diversification
Target-date funds are generally broadly diversified, which means they include a variety of asset classes, including stock, bond and cash-equivalent investments. Having a mix of asset types is important because the funds often respond differently when markets change and may help offset each other—when one investment is in favor, another may be down.
You should note that diversification does not ensure a profit nor shield you from loss of principal. However, it may help you ride out market ups and downs. This can take some of the emotion out of investing so you’re not tempted to cash out prematurely. (Find out why cashing out can be costly.)
Time-Horizon Alignment
A target-date fund’s investment mix automatically changes over time. How this shift occurs is called the glide path. Portfolios with a far-term date usually start out with more stocks and are considered to be more aggressive. Investors with longer time horizons generally have a higher risk tolerance than those with shorter horizons because they have more time to recover from any market downturns.
As the target date approaches, portfolio managers dial down risk to be more conservative by reducing the exposure to stocks and increasing exposure to bond and cash-equivalent investments. For example, a target year of 2025 will generally have more bonds than a target year of 2045.
Professional Portfolio Management
When you choose a target-date portfolio, you're often choosing a fund-of-funds option, meaning the portfolio holds several underlying mutual funds. Experienced money managers handle the day-to-day work of adjusting allocations to the underlying mutual funds and determining the appropriate combination of asset classes. They also monitor and rebalance the portfolio to lower risk as the target date approaches.
Convenience in One Choice
You could choose your own selection of stock, bond or money market mutual funds. However, that may involve additional steps and resources. For example, if there are account minimums, you would need to have enough money to invest in each individual fund. You would also need to research each investment option to know how much of each to hold in your portfolio. Choosing a target-date fund gives you the convenience of a diversified portfolio in a single investment.