“Don’t put all of your eggs in one basket.”
Ever heard that saying? Sure you have. It is a message that has been forced, reinforced, and dare we say, hard boiled – sorry, we couldn’t resist! – into all investors. The logic is simple and sound. By spreading your funds across multiple investments you never risk losing all of your money on one bad bet.
It’s time-tested advice. Airtight in all circumstances. Never disputable. Right? Well….no, not exactly. Case in point: Target date funds.
To understand why target date funds are an exception to this general rule, it is first helpful to understand what a target date fund is. Simply stated, a target date fund is an investment fund designed for one purpose: To invest your money in preparation for your retirement, referred to as your “target date.”
The manager of the target date fund allocates your portfolio into a variety of stocks, bonds, and cash. As you approach your target date (i.e., your retirement), the fund manager automatically reduces your exposure to riskier investments, like stocks, and increases your exposure to less volatile investments, like bonds and cash. And that happens without you doing anything – a tremendous benefit and convenience for investors who do not have the time or expertise to make those types of decisions.
If a target date fund sounds ideal for you, the process of determining which target date fund you should use is simple. First, identify the year you would realistically like to retire. Then, choose the target date fund with a date closest to that year. For instance, let’s say you plan on retiring in the year 2033. In your 401(k) plan you would likely have a Target Date Fund 2030 and a Target Date Fund 2035 available. In that case, you would simply place all of your 401(k) assets into the fund with the year closest to 2033 – in other words, Target Date Fund 2035.
And that brings us back to why target date funds are the exception to the investing adage at the start of this memo. Because target date funds, by their very design, invest your assets in a fully diversified and age-appropriate manner, you can sensibly place all of your 401(k) dollars into one fund without exposing yourself to the risk of making one bad bet.
In essence, your investment in one fund provides a complete portfolio.
Keep in mind, a target date fund is not right for every investor. If you have a large percentage of your net worth in investments outside of your 401(k) plan, a target date fund may not be a good fit for you. Also, if you have a higher or lower risk tolerance than the average person, a target date fund may not be a good fit for you.
For many individuals without an investing background, however, a target date fund offers a solid alternative. And it's far better than simply throwing darts to select the funds that will ultimately carry you through retirement.