A target-date retirement fund is a way to put your nest-egg savings on autopilot. This type of mutual fund allocates money for investors based on the years remaining until the fund's target date is reached. This date generally matches your expected retirement year. The closer the fund's termination date gets, the more conservative the assets are allocated. While the fundamental principal behind this investment approach may be sound, target-date funds can carry risks.
When you invest in a target-date fund, you're pooling your assets with other investors; the fund's managers don't build a different portfolio for each investor. As a result, you're left with a generic asset allocation that's the same for everyone. Initially, target-date funds hold mostly stocks, with a sprinkling of bonds and cash. As the target date gets closer, they funnel more money into bonds and cash and less into stocks. The fund investments may not match up well with your personal goals or risk tolerance. The managers have no knowledge of any outside investments you hold, so the fund's allocation may not complement your other assets. A target-date fund may increase the risk in your overall portfolio if you already have similar investments on your own.
Target-date portfolios are not actively managed like many traditional mutual funds. They are usually on a predetermined allocation path based on the year, and the shift from stocks to more conservative investments is done automatically. While this is intended to reduce risk as the fund nears its target date, it doesn't use the managers' expertise to actively respond to market conditions. Even if the managers think certain investments will fall in value, the fund will stick to its predetermined investment allocation. This can prove risky in a dynamic market.
As of 2013, the average target-date fund had expenses of more than 1 percent per year, according to U.S. News & World Report. However, some target funds only charge 0.17 percent annually. Funds sometimes justify higher expenses by claiming unique target portfolios or readjustment costs. Expenses eat away at your investment return and can greatly diminish a fund's performance over time. You may be able to replicate the portfolio of a target-date fund on your own, with lower yearly expenses and more control of the investment mix.
Target-date funds are allocated as if their investors will retire when the target date is reached. However, there is no guarantee you will receive a certain amount of money when that time arrives. If you retire in the middle of a down market, your fund may even lose money. This is a risk compared with investing in securities that have guaranteed maturity prices, such as U.S. Treasury bonds. If you buy a government bond with a 20-year maturity, you have a U.S. Treasury guarantee that you will receive $1,000 per bond at the end of those 20 years. Target-date funds carry no such guarantee, which can put your investment money at greater risk.
John Csiszar has written thousands of articles on financial services based on his extensive experience in the industry. Csiszar earned a Certified Financial Planner designation and served for 18 years as an investment counselor before becoming a writing and editing contractor for various private clients. In addition to his online work, he has published five educational books for young adults.