Target date funds are nothing new. Long before ETF’s came into the market, several mutual funds already offered these types of products. What is a target date fund? It is meant to be a one stop solution for investors. Basically, an investor that is expected to retire in 2020 would buy a target date fund with a “2020 target”. The objective here is to provide an easy solution for investors that fit a specific profile.
In this case, investors that are expected to retire in 2020 would want to have a riskier profile than investors retiring in 2015 but less so than in 2025.
How Are Target Date Funds Managed?
In general, most of these funds simply hold other funds. They would usually own other funds such as “Domestic Stocks”, “International stocks”, “Emerging Markets stocks”, they would also own bond funds and sometimes a few others (alternative classes, commodities, etc).
So for example, a 2020 fund could own
-20% domestic stocks
-10% international stocks
-10% emerging market stocks
-30% government bonds
-30% corporate bonds
While a 2030 fund would own:
-35% domestic stocks
-20% international stocks
-20% emerging market stocks
-10% government bonds
-15% corporate bonds
As the years go by, these funds would gradually become safer and less volatile. Seems like a win-win for everyone involved right? Let’s take a look at the main actors involved:
Clearly, fund companies that issue these funds have a lot to gain by selling these funds. Why?
-Clients holdings these hold them for longer periods of time (very profitable)
-These funds have higher fees than most standard funds
-This helps the issuers increase the assets for their sub-funds
-Many of the buyers of target date funds are employers, it’s a simple decision that is easier and less costly to do
-Requires basically no time to manage
-Provides great diversification and decent asset allocation
-The thought that all investors of a given age should have the same asset allocation is crazy, these funds are built for the “average investor” but who is “average”?
-These funds cost more to the holders than would a strategy used with 5-6 ETF’s that would usually generate a similar result
So what are your thoughts on target date funds? I think they clearly have their place in today’s marketplace but they should be mostly used by investors who do not want to or have the ability to manage their selves or who have less assets.