How to choose a target date fund – Forbes Advisor
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Life is complicated enough, so retirement planning shouldn’t be. Choosing a target date fund can make retirement planning a lot easier.
With just one target date fund, you can tick off all the essentials of a smart long-term investment. This special type of mutual fund handles all asset allocation decisions, basing its mix of stocks and bonds on how many decades you have left before you retire. And because a target date fund has several different mutual funds, you get an instantly diversified portfolio.
That said, not all target date funds are the same (hint: fees!). Apply a little elbow grease to make sure you choose the fund that best suits your needs.
Target date funds make retirement planning easier
Anyone can invest their retirement savings in a maturity fund. It’s just a matter of where you choose to make your investment.
If you have a workplace retirement plan, such as a 401 (k) or 403 (b), chances are there is only one set of target date funds of a year. investment manager, for example Vanguard, Fidelity or BlackRock. Your choice is limited to choosing the target date fund whose target year is roughly when you plan to retire.
If you have an Individual Retirement Account (IRA) at a discount brokerage firm, you may have the option of choosing between the brokerage’s own target date fund as well as target date funds from other companies, although additional fees may be charged for the latter options.
How to choose a target date fund
The best target date funds have low annual expense ratios. If you are just starting to invest in retirement, low cost discount brokerage firms may be the best place to open an IRA. There is another decision you need to make: Whether it’s to save for retirement in a Traditional IRA or a Roth IRA.
If you do not have a workplace pension plan and want to save more than the current limit of $ 6,000 on annual IRA contributions ($ 7,000 if you are at least 50 years old), you can also invest in a target date fund in a regular taxable account. .
How many years do you have before you retire?
All target date funds have a year in their title. There are target date funds that operate in five-year increments from around 2020 to 2065. Year refers to when the fund assumes that an investor will approach the traditional retirement age of around 65.
The asset allocation of a target date fund in stocks and bonds is linked to the date of its name. The later the date, the more emphasis the fund will put on equities. But over time, the target date fund will adjust its composition to become more conservative; the formula guiding the evolution of a fund’s asset allocation is called its descent path.
The key to long-term investing is owning the right mix of stocks for their long-term potential growth, beating inflation and certain bonds to stabilize your portfolio when stocks hit one of their intermittent periods of decline. valuable.
There is no hard and fast science about how to properly allocate assets between stocks and bonds, but as a rule of thumb, the decades you plan to retire, the more you should favor stocks over bonds.
As an example, the Fidelity Freedom Index 2060 fund would be a suitable choice for someone in their mid to late twenties today. He currently owns around 90% investments in US and international stocks and 10% in bonds. In 35 years, as today’s 25 years approach 60, the 2060 fund’s evolution plan will target a mix of roughly 60% stocks and 40% bonds and cash. Indeed, the Fidelity Freedom Index 2025 fund, which may be meaningful to someone nearing retirement today, currently has around 60% investments in stocks and 40% in bonds and cash.
How diversified is a fund option?
About 45% of the total global market capitalization is in companies based outside of the United States. “You want to peel the onion off a target date fund and make sure it owns international stocks,” says David D’Eredita, founder of Rise Private Wealth Advisors in Tucson, Arizona.
You can find this basic portfolio information on a fund’s information page – do a quick web search for the fund’s name – as well as on the website for where you own your 401 (k ) or IRA. When you click on the ‘portfolio’ tab, you should also confirm that the equities portion includes small and mid cap stocks, and not just large cap brands, like Facebook and Google, which most people are familiar with.
“The market isn’t just limited to large caps, and there are times when small cap stocks do better,” explains D’Eredita. For example, although large-cap stocks have been performing well in recent years, from 2000 to early June 2021, a small-cap stock index tracking the performance of small companies reported nearly double the gain in the S&P stock index. 500.
Watch out for fees
If you are investing in an IRA or a regular taxable account at an online brokerage firm, you have the flexibility to choose from a variety of target date funds offered by different portfolio management companies.
The key when investing in target date funds is to keep your annual costs low. Each mutual fund charges an annual fee, called an expense ratio. It is not listed on your statement as a cost you paid, but it is a charge that is deducted from the performance reported for your fund.
Morningstar’s recent target date fund survey indicates that the asset-weighted average expense ratio of target date funds in 2020 was 0.52%. This means that if a fund had a gross return of 7% (before fees), the net return after expense ratio that investors would see is 6.48%.
Do they look like little potatoes? It’s anything but. The best low cost target date funds have expense ratios of around 0.10% because they focus on holding index funds. Target date funds that use actively managed funds, which means that someone selects each stock or investment individually instead of just trying to recreate the performance of an index, have higher expense ratios that can be achieved. 0.70% or more. (It’s also important to note that they generally have the same, if not worse, performance than index funds.)
Save $ 6,000 a year in a 30-year target date fund that charges 0.10% and you’ll have about $ 590,000 assuming a gross annualized return of 7%. Pick a target date fund with an expense ratio of 0.70% and you’ll get around $ 530,000.
“It’s $ 60,000 less for retirement, just because of what looks like a minimal fee,” D’Eredita says. “Choosing a low cost target date fund is so important. “
Enjoy being on autopilot until you approach retirement
Once you’ve chosen a target date fund and set up automatic contributions (increasing your contribution rate over time also makes sense), sit back and relax. The portfolio management team that manages your fund will periodically rebalance the portfolio to ensure that it stays within its target mix of stocks and bonds.
As you approach retirement and your goal shifts from building savings to developing a plan to generate reliable income to live on in retirement, you may benefit from careful consideration if the distribution of your target date fund assets are still the right mix for you. For example, if you expect your living expenses to be covered by your Social Security benefit and a pension, you might be comfortable investing more in stocks than a target date fund for a person. 60 or 70 years old.