Planning for retirement can be stressful: How much money will I need? How should I save it? What will help me ensure the lifestyle I want after I leave the workforce? There are so many savings vehicles, both employer-sponsored and independent, to choose from. You may have heard of one kind called a target-date fund and not been quite sure what it is or how it works. Here’s the rundown.
A target-date fund “targets” the year you want to retire. You’ll likely see this option when you are choosing how much to contribute to your 401(k). When picking a target-date fund to use as your retirement-savings vehicle, you choose your expected retirement year. You may not have the exact year as an option, since these tend to be offered in five-year or 10-year increments, so choose the year closest to your expected retirement date. The mutual fund invests in stocks, bonds, and cash equivalents, continuously re-balancing based on performance and the proximity to your target date.
When you are young and your date is far away, a target-date fund will give you more exposure to risk for greater potential future reward. When you begin getting closer to your date, your portfolio will become less risky. To be clear, the returns on this long-term investment strategy always depend on the markets and are not guaranteed.
Pros & Cons
One of the best aspects of a target-date is convenience for investors. The fund does the work of rebalancing and adjusting for risk tolerance as you get closer to retirement. Since your risk is determined by the investment firm managing the fund, you do not have the chance to adjust your allocations unwisely so many think it can save you from yourself. Since these funds are easy and low-risk, you may be thinking that there has to be a downside.
Some critics think target-date funds are not specialized or personal enough as different people are comfortable with different levels of risk. Just because you’re further from retirement, doesn’t mean you may want the level of risk pre-determined by a 2060 target-date fund, for example. No matter your feelings about how many stocks your retirement fund should hold, you will have the same breakdown as anyone else who picks that same fund. These funds can also come with hefty fees.
Of course, just because you have a target-date fund doesn’t mean that’s the extent of your retirement plan. Keep in mind that target-date funds don’t take into account your other investment vehicles or their risk level.
Should I Get One?
Ultimately, target-date funds are primarily for investors who would like a mix of asset classes without all the effort it would usually require to get that. You may want to consider such a fund if you do not want the responsibility of actively managing your portfolio as you age.
While it can offer diversification, ease and automatic adjustment benefits, it’s important to think carefully as you set a target date for retirement. You can also use these as an additional income strategy, setting the date for before or after your actual estimated retirement time depending on if you want to be less or more aggressive respectively.
Deciding if a target-date fund is right for you does not follow a formula. It’s a good idea to consider how comfortable you are with risk, how hands-on you like to be with your investments, what other financial resources you have, and the retirement you want to achieve to help figure out if this is right for you. This is your hard-earned money and your retirement, so it’s important to understand what you are getting into.
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This article originally appeared on Credit.com.