Investing for Your Life Cycle: Understanding Target Date Funds

Target date funds, also sometimes called life cycle funds, offer some simplicity, but it’s important to be aware of the drawbacks before investing.

https://tickertapecdn.tdameritrade.com/assets/images/pages/md/Target date funds, life cycle funds, managed funds
5 min read
Photo by Getty Images

Key Takeaways

  • Target date funds can help you simplify your portfolio 
  • Watch out for fees with target date funds 
  • Don’t assume life cycle funds are right for everyone

Shoppers of a certain age remember the days when buying peanut butter was a relatively simple affair. There were two brands, and each had a creamy and a chunky variety. Nowadays there’s an entire aisle filled with store brands, boutique brands, some “all-natural” versions, sugar free, and about six different sizes.

Choice is awesome, but too much can be overwhelming.

Some people feel the same way about investing, and that’s where target date funds come in.

According to Keith Denerstein, the director of investment products and guidance for TD Ameritrade, a target date fund features simplicity that can help some investors create a portfolio that meets their needs. However, he warned, not everyone benefits the same way, so it’s a good idea to consider your situation before moving forward.

What Is a Target Date Fund?

A target date fund, also called a life cycle fund, is a type of mutual fund made up of investments designed to help pursue goals over a certain time frame. As you progress toward your goal, the allocations in your fund change based on your expected risk tolerance.

“Target date funds make assumptions based on your time horizon,” said Denerstein. “You choose a fund based on when you expect to meet your goal, whether that’s retirement or sending your first child off to college.”

When you get closer to reaching your goal, Denerstein explained, a life cycle fund will undergo changes to the portfolio’s holdings. When you’re further from your goal, the fund relies more heavily on stocks and other growth investments. As you approach the goal, your allocation changes to reflect more income investments and assets considered a lower in risk by fund managers.

But these funds aren’t for everyone, as there are pros and cons of target date funds. Here’s a snapshot.

Pros of Target Date Funds

Some of the potential advantages of using a life cycle fund include:

  • Simplicity. A target date fund allows investors to basically “set it and forget it” without the need to worry about complicated strategies of changing the portfolio to be more conservative as time goes on. No need for the investor to remember to tweak the portfolio.
  • Broad diversification. Just as with other mutual funds and portfolio products, rather than trying to pick the “right” stock, some investors benefit from the broad-based diversification that comes with mutual funds.
  • Professional asset management. Target date funds have managers. They aren’t necessarily actively managed, but they’re subject to more management than a passive vehicle such as an index fund. Of course some may claim this is a disadvantage, as the managers could underperform. 

Cons of Target Date Funds

A target date fund isn’t right for everyone. Here are some potential drawbacks to consider before moving forward:

  • Assumptions are based entirely on the time horizon. A life cycle fund won’t consider your other assets, and it doesn’t know your age or personal risk tolerance.
  • Not all funds take the same approach. Managers take different approaches to life cycle fund management, so it’s important to read the prospectus. The manager might not match your style and expectations.
  • Fees. Although many managers use low-fee investments and funds for life cycle fund products, there are still management fees to consider. Carefully compare fees to determine what makes the most sense for you, and watch out for target date funds that charge high management fees.

Considering Target Date Funds?

“The key thing to understand is that if there’s a particular date in the future when you expect a goal to be accomplished, it’s worth investigating a target fund,” said Denerstein. “Retirement and college savings can be examples because you have a pretty good idea of when you’ll need the money.”

He also pointed out that many investors don’t want to go through the time and effort it takes to put together a portfolio that meets their needs. For those investors, a target date fund might make sense. It combines simplicity with a performance that is likely to be adequate, depending on various market conditions.

However, target date funds aren’t a cure-all, and they aren’t appropriate for everyone. And remember: life doesn’t always go in a straight line.

Think of it as you would an airplane coming in for a landing—what’s known as a “glide path.” Once it’s locked in, it only changes if there’s an emergency. And changing the glide path can be quite disruptive. Target date funds also have a glide path, and because it’s the same portfolio mix for all investors in the fund, it’s not customizable to you. So if life forces you to change your plans, i.e., change your target date, you’d need to liquidate your fund shares and shift to other investments.

What Are Some Alternatives to Target Date Funds?

If you aren’t sure a life cycle fund is the right choice for your circumstances, there are other ways to go about pursuing your goals.

Managed portfolios can make sense for some investors, depending on their needs and goals,” said Denerstein. “There are different types of managed portfolios that take your preferences into account and can be tailored to more accurately reflect your financial and life situation.”

Managed portfolios are often built on preexisting strategies and can be tailored (or adjusted) a bit based on what you hope to accomplish as an investor. These managed portfolios can also be rebalanced automatically to reflect personal risk tolerance.

“Another choice, if you have the time and inclination, is to just manage your portfolio yourself,” said Denerstein. “There are different ways you can do the research and put together your own portfolio to help meet your needs.” However, it does take more time and effort. Knowledge is required, and investors need to remember to rebalance their portfolios as their goals approach.

In the end, there are plenty of strategies available to investors, depending on their interests and what fits their needs and styles.

“Think about your own needs as an investor,” said Denerstein. “Then choose products that are most likely to help fit those needs.”

Print

Key Takeaways

  • Target date funds can help you simplify your portfolio 
  • Watch out for fees with target date funds 
  • Don’t assume life cycle funds are right for everyone

Related Videos

Call Us
800-454-9272

Content intended for educational/informational purposes only. Not investment advice, or a recommendation of any security, strategy, or account type.

Be sure to understand all risks involved with each strategy, including commission costs, before attempting to place any trade. Clients must consider all relevant risk factors, including their own personal financial situations, before trading.

*Advisory services are provided by TD Ameritrade Investment Management, LLC, a registered investment advisor. Brokerage services provided by TD Ameritrade, Inc. TD Ameritrade Investment Management provides discretionary advisory services for a fee. Risks applicable to any portfolio are those associated with its underlying securities. For more information, please see the Disclosure Brochure (ADV Part 2).

Carefully consider the investment objectives, risks, charges, and expenses before investing. A prospectus, obtained by calling 800-669-3900, contains this and other important information about an investment company. Read carefully before investing.

Mutual funds are subject to market, exchange rate, political, credit, interest rate, and prepayment risks, which vary depending on the type of mutual fund.

Diversification does not eliminate the risk of experiencing investment losses.

adChoicesAdChoices

Market volatility, volume, and system availability may delay account access and trade executions.

Past performance of a security or strategy does not guarantee future results or success.

Options are not suitable for all investors as the special risks inherent to options trading may expose investors to potentially rapid and substantial losses. Options trading subject to TD Ameritrade review and approval. Please read Characteristics and Risks of Standardized Options before investing in options.

Supporting documentation for any claims, comparisons, statistics, or other technical data will be supplied upon request.

This is not an offer or solicitation in any jurisdiction where we are not authorized to do business or where such offer or solicitation would be contrary to the local laws and regulations of that jurisdiction, including, but not limited to persons residing in Australia, Canada, Hong Kong, Japan, Saudi Arabia, Singapore, UK, and the countries of the European Union.

TD Ameritrade, Inc., member FINRA/SIPC. TD Ameritrade is a trademark jointly owned by TD Ameritrade IP Company, Inc. and The Toronto-Dominion Bank. © 2020 TD Ameritrade.

Scroll to Top