Target Date Funds as a Retirement Investment Vehicle
Sunday, March 17, 2019
Nowadays, many defined contribution retirement plans and 401K retirement plans offer target date funds.
Target date funds, also known as life-cycle funds, are mutual funds designed to target an estimated retirement date/year. For example, Vanguard Target Retirement 2030 Fund (ticker symbol VTHRX) is advertised to serve investors planning to retire between 2028 and 2032. Vanguard Target Retirement 2060 Fund (VTTSX), on the other hand, is designed for investors planning to retire between 2058 and 2062.
So how does a target date fund work? A target-date fund assumes investors will withdraw money from the fund around the retirement year. The target retirement date thus determines the fund investment strategies.
Most target funds have an allocation mix of the investment assets that is automatically adjusted over time as the target retirement year approaches. For example, by January 2019, Vanguard Target Retirement 2060 Fund (VTTSX) holds 54 percent of its assets in total stock market index, 36 percent in total international stock index, 7 percent in total bond market index and 3 percent in total international bond index.
Since there are 40 more years until the target retirement date to weather the ups and downs in the stock market, the fund invests 90percent of its assets in stocks and 10percent in bonds. In contrast, Vanguard Target Retirement 2030 Fund (VTHRX) currently holds 70 percent in stocks and 30 percent in bonds.
As the years pass by, the mix of stocks and bonds can change with increasing bond proportion and decreasing stock proportion.
Target date funds can offer many benefits for investors. First, investors can have a diversified portfolio even though they invest in only one single target date fund. This is because target date funds invest in a variety index funds which in turn hold a diversified portfolio of stocks and bonds.
Second, the automatic adjustment of the portfolio allocation mix means less work for investors. Third, the same automatic investing and rebalancing process takes out the emotional biases investors might commit when picking individual stocks to invest.
As with any mutual fund investments, investors pay a fee (also called expense ratio) to invest in any target date fund. Most target date funds have a very low expense ratio.
Vanguard Target Retirement 2030 Fund has an expense ratio of 0.14 percent on a minimum investment of $1000. Vanguard Target Retirement 2030 Fund has an expense ratio of 0.15 percent on the same minimum investment. Finally, as with any stock market investments, there is no guarantee of the returns on target date funds.
Thanh Ngo is an associate professor in the Department of Finance at East Carolina University.