How to Use Target Date Funds to Build Wealth for Retirement

People always say that you should save for retirement. That you’ve got to start amassing funds early on in order to live comfortably post-career. But the question many want to know is exactly HOW to save for retirement. Do you just set up a separate bank account and funnel bits of your paycheck into it over time? Or do you keep your funds in a lockbox labelled “Retirement” under your bed for 50 years and hope for the best? (Okay, probably don’t do that.)

The best way to save for retirement is actually not to save at all. It’s to take advantage of investing in assets like ETFs, mutual funds, and individual stocks, whose growth compounds over time thanks to the power of the stock market. Now, the stock market sounds really scary to many. Most people think it involves detailed tracking of numbers and making strategic financial calls but in reality, it can actually be as simple or as complicated as you want it to be.  If you’re just looking for a good way to save for retirement without all the hassle of creating and managing an active individual stock portfolio, one easy passive investing option is to use a target date fund.

Hey Lisa, what’s that?

In the simplest terms, a target date fund is one and done investment strategy that does all the complicated investing stuff for you. It’s basically a collection of financial assets - everything from stocks and bonds to cash like securities - that is managed by a company on your behalf. These funds are designed to be held for a long, extended period of time - specially until a pre-designated retirement date. They are dynamic, meaning they change and shift to better fit the holder’s needs throughout their lifetime. 

Target date funds usually begin like ordinary stock portfolios targeted on growth and expansion, but then shift over time to be more focused on the preservation of funds for eventual use by the holder. They’re also totally customizable to your personal investing and risk-taking style. If you like to live on the wild-side with your money, you can select a fund with a high risk tolerance, opening the fund up to more risk but also great financial reward. If risky business is not your kind of business, there are also moderate and low risk tolerance funds with which will keep your money safe but your money will grow at a slower rate. 

This approach to investing is totally hands off. All you do is set up the account, funnel your money in, select one target date fund, and the portfolio will do the rest for you. Your money will grow exponentially over your lifetime, leaving you with a healthy sum to use during retirement. It can be a high reward, low stress system that millions of people will take advantage of to build wealth for retirement. 

Although target date funds are popular, they’re not perfect for every single person. Depending on what you want to do with your money and your own investing personality, target date funds might not be quite what you’re looking for. 

Like everything in life, target date funds have specific pros and cons that you should be aware of before you start investing in them:

Pros of Target Date Funds

1. They’re HELLA simple!

Like I said, target date funds are super hands-off. You can pretty much just contribute a certain amount of money into the fund on a regular basis and forget about it until retirement. Meanwhile your money will grow as the fund invests in stocks and bonds based on your personal risk-tolerance. Then once the retirement date you set rolls around, CHA-CHING! Money for you to use to buy that cottage by the sea or whatever you heart desires. Using target date funds is so simple even a monkey could do it. (Maybe don’t quote me on this as I’ve never personally worked with monkeys, but I hear they’re pretty dang smart!) So, if you feel your investing know-how and skills are currently pretty minimal, target date funds may be a good place to start. 

2. No matter who you are, they’ve got something for you!

These funds are designed to be a sort of one-size-fits-all style of investing approach and they’re usually an option for you whether you have a retirement plan through an employer or through your own individual retirement account (IRA). Target date funds are available for a variety of risk tolerances. Say your target retirement year is 2055 but you want a higher risk portfolio with a potential for greater profits like for someone who’s 10 years younger than you...you can choose a 2065 target retirement date instead. The great thing is that target date funds don’t have ‘rules’ so you don’t have to put yourself in a box based on your estimated retirement year.

3. They’re managed by real people!

There are various full service brokerage firms out there that have their own proprietary target date funds for retirement investing namely companies like Fidelity, Charles Schwab, and Vanguard. That means there are professionals behind the scenes managing the stock and bonds inside of the target date funds. Although investors eventually hand the reins off to the fund manager after you invest in the fund inside of your retirement account, investors may feel more at ease knowing that real people are managing the fund holdings for them. 

Cons of Target Date Funds

1. They’re not exactly fool-proof

Although they can sound like a pretty sweet deal, target date funds aren’t a guarantee you’ll have millions during retirement. Because you also have to invest consistently over many years and there is always a certain amount of calculated risk like there is with any type of stock market investment. Stock market volatility will always be a factor because the stock market moves in cycles. But, have peace of mind knowing that there have been many more up years than down years in the financial markets and the US market has returned an average of 10% per year over the past century. I’m willing to bet that’s a lot more interest than any bank account is paying you. So regardless of how much you end up with when your target date fund expires, know that consistency with investing over 25+ year horizon along with taking calculated risk is really the key to having enough money in retirement.

2. They require some research

Target date funds are a much more hands-off type of investing, but that doesn’t mean investors should leave them totally to chance. In order to make sure you’re getting what you need for retirement, it’s important to do some research on what is included in your fund. Different funds may all have the same end date, but they won’t all contain the same stocks, have the same interest rates, or allocation percentages. So, doing some research, and cross-checking the investments within different funds can be hugely beneficial to investors. That way you can make smart and informed decisions about exactly which target date funds you want before purchasing. 

3. Beware of hidden fees

Another important reason to do research on target date funds and exactly what is included in them, is because of the possible hidden fees that can come along with them because they are actively managed mutual funds. This means that because a team of people is behind the curtain managing this fund, you’re paying for their services. As a result, some target date funds can have annual fees up to 1.5% which is not exactly ideal when you can invest in more cost effective passively managed index funds where annual fees can be as low as 0.08%. To put that simply, for every $10,000 you invest into an investment at 1.5% you’ll pay $150 in annual fees and for every $10,000 you invest into an investment at 0.08% you’ll pay $8 in annual fees - a massive difference when you have say $200,000 invested. Would you rather pay $3,000 per year or $160? But that doesn’t mean all target date funds are bad, money-guzzling investments. If you do your research and find funds with low annual fees (around 0.20%), you can strike a pretty good balance between how much you're saving for retirement and how much of your profits you’re forking over in fees. 

4. There’s a minimum investment required

It’s important to know that most mutual funds have a minimum initial investment requirement anywhere from $500 - $5000, the same goes for target date funds because they are mutual funds. This can make them less accessible to investors than passively managed index funds that don’t have any minimum initial investment requirement.

Like everything on the stock market, target date funds aren’t a guaranteed way to make millions for retirement. What they are is one option of many to help investors start saving for retirement early, without having to worry about what’s going on in the stock market. If you are intentional in your research, target date funds can be a great option for investing for retirement. 

Sources:

What are target date funds? - Morningstar

Pros and Cons of Target Date Funds - Investopedia 

Index Funds vs. Target-Date Funds: What's the Difference? - Investopedia

Target Date Funds: Find the Right Target for You - Finra

What are Target Date Funds? Should I Invest in One? - Ramsey Solutions

The Trouble With Target Date Funds and How to Use Them Effectively - The College Investor