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Target date funds: Letting time do its work

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The options available in your retirement investment accounts can seem overwhelming. Various mutual funds combine different assets like stocks and bonds, and navigating them can feel tricky. One smart way to narrow down the options for your retirement savings is to learn more about the different categories of funds.

A commonly available one is a target date mutual fund. These funds—which are commonly offered through 401(k) plans—help investors navigate the common concern about how much, or little, risk to include in their portfolio. The general principle is that the younger you are, the more aggressively you can invest, generating strong returns but also allowing for time to recover from down markets. As you near retirement, it's wise to reallocate investments to less risky investments. A target date fund is specifically designed to take the guesswork out of rebalancing, tying your investments' risk tolerance to how many years you have before retirement.

Understanding the convenience of these kinds of funds and the costs associated with them can help you choose investments that make sense for your goals.

What is a target date fund?

A target date fund usually includes a year in its name that refers to when its target investors generally plan to retire and begin withdrawing their money. You simply decide when you think you will retire and invest your assets in a fund with that target date.

Funds like these are expertly coordinated by an investment manager or use an algorithm. Early on, the manager will likely lean toward investing your funds according to a more aggressive strategy that offers more potential for growth but may also have more risk. As time passes and your retirement approaches, the manager will adjust the asset mix to align with a more conservative strategy, where more of the assets are stable even if the potential for high returns is reduced.

The mix of assets in a target date retirement fund is guided by the investing concept of diversification.* Investing in a variety of assets can offer less risk than investing 100% of your savings in a single asset, such as the stock of just one company or just one piece of real estate. With a target date fund, the manager takes care of selecting the mix of assets to invest in and the gradual transition of asset mixes over time—giving the investor the benefit of a sound risk management strategy with diversified assets.

Why use a target date fund as part of your strategy?

Many investors aren't sure what their mix of assets should be, or they don't know when to shift from riskier investments to more secure ones. It can be challenging to stay on top of or even be familiar with which stocks, bonds or mutual funds truly align with your preferences for risk versus return potential. If you're new to investing and are learning the ins and outs of risk and dollar-cost averaging, these funds offer you the ability to adhere to best practices in a single fund, without having to make large initial investments.

A target date fund can be a convenient, all-inclusive way to invest that takes care of adjusting your investment risk appropriately over the years. The phrase "all-inclusive" means you don't personally need to rebalance or choose the funds periodically to adjust your risk—a single target date fund does that for you. Plus, it can allow you to offset some of the impact of inflation on your money by generating returns while also lowering risk and reducing the impact of a market shock right before your retirement.

While some investors use a target date fund for all of their invested assets, that isn't the only way forward. As you grow your understanding of investing, it's wise to talk with a financial advisor about whether using only a target date fund is serving all your goals. It's possible to use this kind of fund as a core part of your investments while also complementing that fund with other fund choices. Some investors want a more specific investment time horizon and risk tolerance, so combining target date funds with other funds can offer a more attuned investing experience aligned with your goals.

Risks and considerations for target date funds

While target date funds offer a number of benefits, they might not be a good fit for every investor. Here are a few potential drawbacks to keep in mind as you consider your options:

  • Higher fees. Target date funds often consist of other mutual funds. At each level, investment managers handle the activities of buying and selling stocks, bonds and other assets. That means there are fees and expenses for your portfolio at each level. As a result, all-in-one funds like target date funds can have higher costs than other mutual funds.
  • Must be adjusted if your plans change. Another potential issue with selecting target date funds is that your retirement intentions can change over time. While you can transfer your money from one target date fund to another, your already invested money will have been on a different risk trajectory, which may affect how your investments grow over time. This is something to consider if you think there's a possibility you might wish to retire earlier or later than planned.
  • Can alter a diversified portfolio's risk level. One other consideration is that if you invest in target date funds as well as other investments, you may or may not be hitting your optimal risk level at any given time. The idea of simplified, all-in-one investing can be nice—but especially when it comes to coordinating a wide portfolio of investments, easy doesn't mean optimal. A financial advisor can help you look objectively at how target date funds, plus all your other investments, align with your overall risk tolerance and goals.

How target date funds fit in your big picture

Thrivent financial advisor understands how target date funds and other investment opportunities work together toward your financial goals. They'll help you evaluate what the terms and conditions are for different funds so that you can make an informed choice about your investments. Having a professional to journey with you on the road to retirement helps you rebalance your portfolio over time, making changes in response to everything from market conditions to a change in when you'd like to retire.

*While diversification can help reduce market risk, it does not eliminate it. Diversification does not assure a profit or protect against loss in a declining market.