Target date fund

Defintion

A target date fund, also known as a lifecycle or retirement fund, is a type of investment fund that is designed to provide a simple, long-term investment strategy for individuals planning for retirement.

What is a target date fund

These funds are structured to automatically adjust their asset allocation over time, becoming more conservative as the target date (usually a retirement year) approaches. Here are some key points about target date funds:

1. Long-term investment strategy:
   • Target date funds are intended for long-term investors, typically those saving for retirement.
2. Asset allocation adjustments:
   • The fund’s asset allocation is initially more aggressive, with a higher proportion of equities (stocks) for potential growth. As the target date nears, the allocation shifts towards more conservative investments like bonds and cash.
3. Diversification:
   • These funds are diversified across various asset classes, such as domestic and international stocks, as well as bonds.
4. Risk tolerance consideration:
   • Target date funds are structured to match a typical investor’s risk tolerance at different stages of their life. Younger investors with a longer time horizon have a higher risk tolerance, while those nearing retirement tend to prefer lower risk.
5. Automatic rebalancing:
   • The fund manager periodically adjusts the asset allocation to align with the target date’s investment objectives. This rebalancing is done automatically, sparing investors from the need to make manual adjustments.
6. Simplified approach:
   • Target date funds offer a straightforward investment strategy, making them suitable for investors who may not have the expertise or desire to actively manage their investments.
7. Customised target dates:
   • Funds are often labelled with a specific year (e.g., 2030, 2040) corresponding to an investor’s expected retirement date. Investors choose a fund with a target date closest to when they plan to retire.
8. Transition to retirement:
   • Even after the target date is reached, the fund continues to be managed. This reflects the fact that retirees may need their investments to last for several decades into retirement.
9. Variation among fund families:
   • Different fund providers may have varying approaches to how they manage their target date funds, so it’s important to understand the specific strategy of a particular fund.
10. Fees and expenses:
    • Like any investment, there may be fees associated with target date funds, including management fees and expenses. These costs can vary among different funds.
11. Consideration of other investments:
    • Some investors may choose to complement their target date fund with additional investments to tailor their portfolio to their specific financial situation and goals.

Target date funds can be a convenient option for investors seeking a hands-off approach to long-term investing, especially for retirement planning. However, it’s important for investors to carefully review the specific details and fees of any fund they consider, and to periodically reassess their investment strategy as their financial situation evolves.

Example of a target date fund

Let’s say Sarah is 30 years old and plans to retire when she turns 65. She decides to invest in a target date fund with a target retirement date of 2055.

1. Initial investment: Sarah invests £10,000 in the target date fund.
2. Asset allocation: At the outset, the target date fund’s asset allocation is typically more aggressive, with a higher allocation to stocks and a lower allocation to bonds and other fixed-income investments.
3. Automatic rebalancing: Over time, as Sarah gets closer to her target retirement date of 2055, the target date fund automatically adjusts its asset allocation to become more conservative.
4. Retirement: By the time Sarah reaches her target retirement date in 2055, the target date fund’s asset allocation is geared towards providing income and capital preservation in retirement, with a higher allocation to bonds and cash equivalents.

In this example, Sarah benefits from the simplicity and convenience of investing in a target date fund, which automatically adjusts its asset allocation over time to align with her retirement goals and risk tolerance.