Target date funds: Simplifying retirement investing

I'll admit that I'm not a great fan of target date funds, which allocate assets between stocks, bonds, and maybe other assets based on a predicted retirement year. But this demands an explanation because, as the title suggests, this essay assumes target date funds are a sound investment.

It is extremely personal, just like any other investing decision. Even if someone works with a professional investment manager or financial planner, the final choice on what to do strategically rests with the person whose money is being invested. A target date fund automatically adapts its investment strategy as the investor ages, beginning with riskier, growth-oriented investments and progressing to less volatile investments as the target date approaches. While target date mutual funds and ETFs, both of which are discussed below, allow you to bypass a lot of the complexities and continuing management of your retirement investment portfolio, they should never be used as an excuse to "just let the market and time take care of it."

While target date funds offer a convenient "set it and forget it" approach, it's crucial to understand that they are not infallible. Market conditions can change rapidly, and what worked well in the past may not be as effective in the future. Investors should regularly review their target date fund's performance and asset allocation to ensure it aligns with their evolving financial goals and risk tolerance. Additionally, it's worth considering that these funds may not account for individual circumstances such as changes in career, health, or family situations that could impact retirement plans.

Now, let's look at the target fund decision variables to consider while addressing these creative investments. I don't need to be a major fan of them to understand why others are. And they certainly have stood the test of time.

Some may consider target date funds as a lazy style of investment. Others would argue that investing is challenging enough without having to expect one's emotions to remain stable between now and the time the money is spent in retirement. The primary benefit of investing in target funds is not related to an individual's investment strategy. Because that's a really personal decision that I exclusively make for my own family.

However, what target date funds do that could be extremely beneficial is give something that many, if not most, investors struggle with: constructing their investment portfolio. I worked in portfolio construction for decades. And now, in the years after I sold my advisory practice to semi-retire, I spend my time speaking less directly to investors than when I had a client base, but to a broader audience, hoping that individuals who selected this simplified, organized approach to investing did not lose sight of the goal.

One of the key advantages of target date funds is their ability to provide diversification across various asset classes. This diversification can help mitigate risk and potentially smooth out returns over time. However, it's important to note that the level of diversification can vary significantly between different target date fund providers. Some funds may offer exposure to a broader range of asset classes, including international stocks, real estate, and commodities, while others may stick to a more traditional mix of domestic stocks and bonds. Investors should carefully examine the underlying holdings of a target date fund to ensure it provides the level of diversification they desire.

Target date funds simplify investing by eliminating the need to make ongoing decisions about asset allocation. However, this does not make them less hazardous. Because the markets are still active, target date funds have one inherent disadvantage that all investors should be aware of: they automatically prefer bonds as one approaches retirement age.

This was fine for about 40 years. Then, in 2020, bonds suffered as interest rates increased. That shattered the fundamental premise of having more bonds and a smaller stock portfolio. However, stocks are not without their risks. I'll go over some additional ideas on this at the end of the essay.

The recent volatility in both stock and bond markets has highlighted the importance of understanding the "glide path" of target date funds. This refers to how the fund's asset allocation changes over time as it approaches the target retirement date. Some funds follow a "to retirement" approach, reaching their most conservative allocation at the target date, while others use a "through retirement" strategy, continuing to adjust the allocation beyond the target date. Investors should carefully consider which approach aligns best with their retirement goals and risk tolerance, as it can significantly impact their portfolio's performance in the crucial years leading up to and during retirement.

Criteria Used To Select These Top Target Date Funds

Given the large range of retirement target dates, my research below focuses on funds that seek to retire in 2040 or so. So I'm basically neutralizing the goal date and focusing on the specific companies' offerings in the 2040 section of the fund business. The idea is that if someone reads this who is retiring earlier or later, they will most likely focus on a different year's fund, but the issuer is what I am actually referring to here. They are essentially a money manager hired to outsource the investment process over an extended period of time.

So, with little difference between target date funds other than the fact that the closer one gets to retirement, the more bonds and cash they will have in their target date portfolio, I believe it boils down to fund selection with the target date issuer. As a result, organizations with extensive fund menus and funds that differ from the typical types stand out to me.

3 Top Target Date Funds to Buy (H2)

JPMorgan Smart Retirement Blend 2040 R6 (JOBYX)

JPMorgan need no introduction. However, despite its extensive banking heritage, which dates back to its eponymous founder, it has grown to become one of the leading asset management firms. Despite its size, it has generated some relatively innovative funds.

Fund Overview

• The year of inception was 2012.
• Number of holdings: sixteen.
• Turnover ratio: 22 percent

Why Is JOBYX A Top Choice?

The fund makes this short list because, over time, an issuer's capacity to combine some of their more unique funds with the broader target date fund portfolio could make a difference. Its present portfolio includes non-traditional asset classes like high yield bonds and emerging market debt. The top holdings are Equity Index Fund, BetaBuilders International Equity ETF, and CoreCORE +5.8% Plus Bond Fund.

iShares Life Path Target Date 2040 ETF(ITDD)

Blackrock's iShares business is the 800-pound gorilla of the ETF industry, so it seems to reason that they would utilize their clout to establish themselves in the target date space. This is the only ETF on the list, while other target date funds remain in mutual fund form. That explains ITDD's recent inception and the modest number of assets under management. However, because these funds only allocate to other funds, liquidity should not be a major concern.

Fund Overview

• The year of inception is 2023.
• Number of holdings: 15.
• Turnover ratio: 2 percent.

Why ITDT is a top choice.

Again, the availability of differentiated funds and the implied flexibility stand out here. And as this is an ETF of ETFs, the iShares unit is suitable for target date investment. ITDT now includes three ETFs: global infrastructure, REIT, and TIPS bond. That gives a solid indication of what this ETF behemoth will be capable of when it expands its target date footprint. The top holdings are iShares Russell 1000 ETF, iShares Core MSCI International Developed Markets ETF, and iShares Emerging Markets ETF.

T. Rowe Price Target 2040 (TRHRX).

When it comes to investment, you often get what you pay for. So, T. Rowe Price is worth considering if you want the most diverse fund choices and active management.

Fund Overview

• Inception year: 2013
• Number of holdings: 25
• Turnover ratio: 37 percent

Why TRHRX is a top choice.

With 25 different mutual funds within it, and extending to include asset classes such as commodities ("real assets" as they are referred to in this fund) as well as various types of small-cap stock and non-U.S. stock funds, this one fits more of the classic target date fund mold, but with a very diverse selection of sub-funds). Top holdings include T. Rowe Price Value, T. Rowe Price Growth Stock, and T. Rowe Price U.S. Large-Cap Core.

When evaluating target date funds, it's crucial to consider the fees associated with these investment vehicles. While they offer convenience and professional management, the costs can vary significantly between providers. Some target date funds may have higher expense ratios due to their active management approach or the inclusion of more specialized underlying funds. Others may keep costs low by primarily using passive index funds. Investors should carefully weigh the potential benefits of a more actively managed or diversified fund against the impact of higher fees on long-term returns. Additionally, it's worth noting that some employers may offer discounted fees on certain target date funds within their 401(k) plans, which could influence the decision-making process.

Many target date funds are similar. They prefer to invest 80% or so in stocks, diversified through funds often run by the target date issuer, resulting in a type of "fund of funds." However, as with the hedge fund version of that structure, there is little hedging done here because the funds are typically designed to automate investment for people who will not be retiring anytime soon. That is why it is critical for investors in these funds to regularly monitor and take proactive steps as they approach retirement.

In other words, it would be a shame to accumulate all of that wealth over time only to lose a large portion of it when the stock market, bond market, or both implode soon before your target date fund reaches its destination date. Furthermore, retirement has evolved from the days of working for a corporation for decades and receiving a pension. Target date funds are essentially a type of self-directed pension, but the company's money is not used to pay you out. Your money is!