Target date funds
Most financial gurus recommend that your retirement portfolio take on less risk as you approach retirement age. In practice, this means that the percentage of your portfolio in stocks should go down as you get older. Seems simple enough, but putting this plan into action can appear daunting. On one end of the spectrum, an investor can simply hand over the keys to a financial advisor and let them handle it. This option can work well for those who have little to no interest in managing their own finances, or simply don’t have the time to do so. The advisor will take a cut, of course, but perhaps it’s worth it to the investor.
On the other end of the spectrum, an investor may opt to manage their own accounts and rebalance them as they get older. While this may seem difficult to some, in reality you may only need to rebalance every 1-2 years. And once you do it a time or two, you’ll find that even a multi-account investment portfolio can be rebalanced in less than an hour.
For those who don’t know how to rebalance a portfolio but would like to avoid paying a financial advisor to do so, there is another option: the target date fund. A target date fund is simply a collection of stocks and bonds that becomes less risky over time. What does this mean? It means that the percentage of the fund invested in stocks goes down over time (and the percentage of bonds goes up). Target date funds are typically named after the year in which you plan to retire. The further out your retirement date, the more aggressive that fund will be.
Take a look at the table below. This is a table of all target date funds offered by my employer. For someone who would like to retire in 25 years, they could simply choose to invest their retirement money in the 2045 target date fund. Since 25 years is considered a long time in the investing world, this fund is aggressively balanced at 87% stocks and 10% bonds. (The remaining 3% is in cash.) Over time, the fund will automatically become less aggressive. As the investor, there is nothing special you need to do. The fund manager takes care of the rebalancing. Keep in mind, however, that there is no free lunch. The expense ratios listed below range from 0.54 to 0.72. This means that 0.54 to 0.72% of your retirement savings will go to the fund manager each year. While these percentages are still less than the 1.0+% fees often charged by a financial advisor, they are much higher than the 0.02 to 0.03 expense ratios for low-cost index funds that an investor could use to mimic the target date funds below.
Pro tip: if you decide to use a target date fund, you don’t always have to choose the fund simply based on the retirement year. A more nuanced approach would be to choose the fund that most closely matches your risk tolerance. For example, let’s say that you want to retire in ten years. At the time of this writing, that would be in 2030. The 2030 target date fund above is comprised of 72% stocks. If you would prefer a more aggressive fund—i.e. one with a higher percentage of stocks—you could simply choose the 2040 target date fund, which is comprised of 84% stocks.
Interested in target date funds? If you are an employee, contact your human resources or benefits department and ask if they are an option. If you are self-employed, contact your 401k manager to ask the same question. The well-known investment corporations Vanguard and Fidelity both offer them.