I can tell you from experience that diversifying your portfolio can be a real headache if you are not sure what the right way to do it is. You could eventually own a large number of equity funds and bond funds. Trying to diversify with the help of stocks can become even more complicated. You would notice that you would have 20 or 30 different shares. Trying to keep track of so many different investments can drive you crazy.
What should an investor do? The simple solution that fits your investment needs is a target date fund. Target date funds take the guesswork out of diversification. Target date funds create a portfolio for you based on your estimated year of retirement. They determine the right portfolio mix based on the number of years remaining until retirement and they bring all your assets back into balance, the closer you get to retirement age. The older you get, the more conservative your investment portfolio becomes.
Benefits of Target Date Funds
The benefits of target date funds are that they adjust the portfolio mix every year. The fund does all the hard work for you. The fund would be structured in such a way that the mix would be strongly weighted towards shares and other growth contributions when you are young. The most important focus is capital appreciation. The fund adjusts automatically as you get older. The focus shifts from capital appreciation to capital preservation. This is how it works:
Let’s say you are 30 and invested in a 2045 guarantee date fund. The mix of the fund would be 70% shares, 25% bonds and 5% cash. Every year the share percentage would fall and the bonds and cash percentages would increase. In 2045, when you retire, the portfolio would be 70% bonds, 20% shares and 10% cash. Your assets would be protected against market fluctuations. This is crucial because most retirees live on a steady income and need a stable, stable source of income.
Disadvantages of target dates
The main disadvantage of target funds is the “one size fits all” approach. Since every investor is not the same, a specific fund may not meet all your needs. An older investor with limited savings may need to be moderately aggressive to achieve capital growth. A target date fund would not achieve this goal for that individual.
Another problem is that target date funds may not be structured as conservatively as they should be. Older investors sometimes complain that some target date funds have fallen almost as much as the general stock market during the 2008 market crash. Some older people even lost 41% of the value of their portfolio.
More employers include target date funds as an option in 401 (k) ‘s. If you want to invest in a target date fund, do not worry if your employer does not offer a 401 (k) option. You can invest one yourself via a traditional IRA or a Roth IRA. Most reputable investment funds offer target date funds. Do your homework before you invest. Contact Morningstar for the rating of your fund. Remember that although funds with a target date do most of the work for you, you still need to review your fund annually to make sure it is right for you.
If you are now looking for funds and want general tips, take a look at these other tips for choosing the right funds for your 401K.
What is your opinion about target date funds? Are you currently investing in one?
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