Target date fund definition
Investment fund balancing risk and reward in accordance with the expected withdrawal date.
Target date fund meaning
A target date fund is a fund investing its assets for a predetermined period. It is expected that investors will need the money or will start to take money out of the fund at a specific date. Usually it will be their retirement year; a target date fund is also called target retirement fund or a life-cycle fund.
The fund invests in assets with higher risk and higher reward (stocks) at the beginning of the period. As it moves closer to the end of the investing period, it transfers the money into lower-risk and lower-reward assets (bonds). This strategy allows a balance between riskier assets and less risky ones. It combines the accumulation of wealth with maintaining a certain level of safety.
These funds are named according to their target date. For example, a fund named 2040 would mean that the target date is the year 2040, when money will be withdrawn.
Advantages and drawbacks of a target date fund
A target date fundis intended as saving for retirement. It invests in equity in the early stages, with the assumption that wealth will grow and there is enough period for coming back if a loss occurs. The fund does not require financial knowledge or high levels of initial capital. As little as a couple of hundreds of dollars could be used in the investment. This fund also offers a high level of diversification since it is investing in different instruments and across different funds.
However, target date funds charge higher fees, which may have a substantial impact on the return generated by the fund. Although the risk-reward strategy can provide benefits for investors, it can pose a danger. The fund assumes that a younger investor can recover if a decrease in portfolio value or loss happens in the early years of the investment because there will be plenty of time until the retirement for the wealth to be built up again. However, the value of the portfolio could decrease a number of times before retirement. In that case there might not be enough time to regain its value after each substantial decrease.