Target Retirement Funds Pros And Cons

By Staff

One of my shortcomings here at Frugal Dad is that I do not provide much investing advice, and when I do, it is fairly generic and focuses more on providing broad strategies rather than specific recommendations. I intentionally avoid the subject of in-depth investment advice for two reasons.  One, I confess to not being that smart on all the various investment types, and there are others out there with stronger backgrounds on the subject.  And two, I like to keep things simple.

Target Retirement Funds

Following that theme of keeping things simple, I have been able to assemble a very modest portfolio of well-diversified mutual funds in my 401(k) account and a Roth IRA. For the Roth IRA, I decided to give target retirement funds a try. Target retirement funds are basically a collection of mutual funds offered by brokerages to provide the right allocation mix based on your anticipated retirement date.  If I was working with short time horizon of say five years, I would select something like a 2015 targeted retirement fund which would be comprised of mostly conservative investments.

Since I have a few years (decades) to go to reach retirement, I selected a 2040 target retirement mutual fund. Who knows, I might not be ready to retire in 32 years, but when I am five to ten years out I want to slowly move towards a more conservative allocation to avoid losing all I’ve worked to save the 25 years prior.  Ideally, I would like for this to happen automatically, without requiring me to log in and make transactions to move funds to conservative investments, rebalance my portfolio, and manually change allocation percentages for new investments.  Target funds are designed to handle all of those chores for you. However, they are not a totally “hands free” investment strategy.

Do your homework before investing in target retirement funds.  Some have fee ratios higher than that of individual funds. Targeted retirement funds have one other potential drawback: they may become more conservative than your risk tolerance is at the predetermined life stage you are in.  For instance, if I am nearing 60 years-old, but love my job, am in good overall health, and would like to work another ten years, I might like to extend a more aggressive mix of equities to maximize growth potential.  That is not possible with money locked away in a targeted retirement fund.

It is possible to invest in a well-diversified mix of low-cost mutual funds on your own, and manage them accordingly as you near retirement. However, it might make sense to make a targeted retirement fund part of that portfolio to further your diversification even more, and give you one less thing to micro-manage related to finances.