Page 46 - DIY Investor Magazine | Issue 34

INVESTING BASICS:
WHAT IS A TARGET-DATE FUND
More common in the US where they are a staple of the
401k account, target-date funds are now becoming more common in the UK. Christian Leeming explains what they are and how you may use them when planning for retirement.
Target-date funds – also called TDFs – enable groups of pension savers targeting a similar retirement date to save together in a single investment fund. The mix of assets within the fund changes over time to reflect the needs of scheme members as they approach – and go beyond – their target retirement date.
Target-date funds are typically mutual funds, designed to grow assets in a way that is optimized for a specific time frame.
The funds address an investor’s capital needs at some future date— the ‘target date’ – with its portfolio allocation becoming increasingly conservative over time. Most often, investors use target-date funds to save for their retirement, but they can equally be used for other key financial goals such as tuition fees, or property purchase.
The funds periodically adjust the weighting of the asset classes they hold to optimize risk and returns for a predetermined time frame; they offer investors the convenience of putting their investing activities on autopilot in one vehicle. Target-date funds usually mature in 5-year intervals; although relatively more expensive than some other types of mutual fund, fees have reduced in recent years.
HOW A TARGET-DATE FUND WORKS
Funds are named by the year the investor plans to use the assets, and are typically used as very long-term investments; eg in July 2017, Vanguard launched its Target Retirement 2065 products – a time horizon of 48 years. TDFs use traditional portfolio management over the term of the fund to meet the investment return objective.
A fund’s portfolio managers use the predetermined time horizon to decide their investment strategy, based on traditional asset allocation models, and determine the degree of risk the fund is willing to undertake, which is adjusted each year.
Initially, a TDF has a high tolerance for risk and is more heavily weighted toward high-performing but speculative assets
such as equities; it’s portfolio becomes more conservative
as it approaches its objective target date, moving into lower risk investments such as fixed-income bonds and cash equivalents.
Each TDF has a factsheet showing the allocation glide path across the entire investment time horizon; they achieve the most conservative allocation at the specified target date. Some also manage funds to a specified asset allocation past the target date, usually more heavily weighted toward low-risk, fixed-income investments.
ADVANTAGES OF TARGET-DATE FUNDS
Target-date funds are popular with investors in the US saving for their retirement with 401(k) plans; instead of creating a portfolio to help them reach their retirement goals, investors choose a single fund to match their planned retirement date.
A target-date fund is the ultimate set-it and forget-it investment and may be the only investment in an investor’s retirement fund. The asset allocation is automatically risk-adjusted over time, with the one constant being the end date.
DISADVANTAGES OF TARGET-DATE FUNDS
The automated nature of the glide path to retirement may
also be considered a disadvantage as it cannot reflect an individual’s changing circumstances, goals and needs.
What if you have to retire earlier than the target date—or want to keep working? Also, as every risk warning will tell you, there is no guarantee that the fund will generate a certain amount of income or indeed any gains at all.
A target-date fund is an investment, not an annuity, and as with all investments, they are subject to risk and underperformance and a fund’s earnings may not beat inflation over the duration.
Because a TDF is technically a fund of funds (FoF) - a fund that invests in other mutual funds or exchange-traded funds - you have to pay the expense ratios of those underlying assets, as well as the fees of the fund, so they may be relatively more expensive than other collective investments. Where a fund
is heavily invested in passive investments – usually ETFs – it would be possible for an investor to buy and hold these investments directly, thereby avoiding double fees, although that is to forsake the simplicity and low maintenance of TDFs.
DIY Investor Magazine · July 2022 46