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Target Date Mutual Funds – The “Bullseye” Fund

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Introduction

 

 

We’ve already covered the basics of mutual funds, what they entail, the types of mutual funds and their classifications – but what about how they control asset allocation? What if there were a way investors can automatically manage their asset allocations – and more importantly, help achieve their investing goals within a few years – or decades if you are looking long-term. In this lesson, we will be covering another type of mutual fund – that being target date mutual funds – as these types of mutual funds could allow you to keep your eye on the prize and help you reach your financial goals even faster through the power of periodic asset allocation adjustment.

 

But before we begin, we would like you to read and agree to the Terms & Conditions of this post before you proceed any further.

Disclaimer: Invest In Wall Street is in no way financially or legally responsible for any investing decisions made by any of our readers and are, in turn, acting on their own free will. The information in this article is purely educational and should not be abused or misconstrued in any way, shape, or form.

 

Target-Date Funds

 

 

A target-date fund is a unique type of mutual fund that automatically adjust the asset allocations of a portfolio according to a timeline, which ends at a future date, such as 2020 or 2030.

The year represents a target for financial goals, such as funding retirement, buying a home, or paying for college. The
allocations in a target date fund adjusts over the life of a fund.

Generally asset allocations are more aggressive the further away from a target date they are, and become more conservative as the target date nears.

For example, a fund with the target date of 2015 might allocate 85% to stocks, 5% to real estate, and the remaining 10% to fixed income. As the fund nears the target date, the asset allocation may become more conservative to preserve capital.

So overtime as the fund nears its target date, the allocation could shift – for example, to 80% fixed income in money markets, with the remaining 20% in stocks.

Assets are automatically allocated over the life of the fund. But exactly how a target date fund adjusts the allocation, and when, varies.

 

 

There are 3 ways target date funds adjust asset allocations, which are known as glide paths.

A glide path determines how much and when a fund allocates more to money markets and fixed-income, and less to stocks and real estate.

The first title glide path is known as”Linear”. The allocation to aggressive assets gradually diminishes over the life of the fund – and a linear glide path offers a gradual adjustment to asset allocation and risk and return over the life of a fund.

The second type of glide path is known as “Steep”. It maintains a higher allocation to stocks in real estate for a longer period of time, but as the fund nears its target date, the allocation quickly changes to bond and money markets.

A steep glide path offers high risk and return, and only becomes conservative as it approaches the target date.

The third type of glide path is known as “Steeped”. This glide path has predetermined time intervals, usually 10 years, where allocations to aggressive investments are reduced.

At the end of a 10-year period, for example, the fund reduces its allocation to aggressive investments and holds the new allocation mix for another 10 years.

Like the steep glide path, the steeped glide path offers higher risk and return.

In addition to glide paths, target-date funds also vary in terms of fund manager discretion.

Some of these funds follow the glide path allocations without deviation. These passive target-date funds generally costs less but don’t adjust to changing market conditions.

Other target date funds give fund managers discretion to deviate from the glide path allegations. These actively managed funds generally carry higher costs, but adjust to market conditions.

 

 

While target date funds are for the benefit of automatic allocation, its important to understand the risk.

Risks Of Target Date Funds

 

 

First, target date funds don’t guarantee a portfolio will meet a financial goal by the target date – after all, these funds are like other investments and are subject to market risks, including fluctuations in the stock market and changes in interest rates.

 

 

Another risk is that target date funds provide a one-size-fits-all solution to portfolio management, but the solution might not meet every investor’s exact needs.

And finally, both passively and actively managed target-date funds tend to have higher fees than other funds because of the built-in automatic management features.

Despite these risks, investors looking for a hands-off approach to portfolio management can find a solution in target-date funds.

Investors who choose this type of fund may not need to devote as much time or energy managing a portfolio as an investor using a do-it-yourself approach.

 

 

Quick Recap

In Review…..

Target-Date Funds

  • A target-date fund is a unique type of mutual fund that automatically adjust the asset allocations of a portfolio according to a timeline, which ends at a future date, such as 2020 or 2030
  • The year represents a target for financial goals, such as funding retirement, buying a home, or paying for college. The allocations in a target date fund adjusts over the life of a fund
  • Generally asset allocations are more aggressive the further away from a target date they are, and become more conservative as the target date nears
  • Assets are automatically allocated over the life of the fund. But exactly how a target date fund adjusts the allocation, and when, varies
  • A glide path determines how much and when a fund allocates more to money markets and fixed-income, and less to stocks and real estate

 

There are 3 ways target date funds adjust asset allocations, which are known as glide paths

  1. ”Linear” – a linear glide path offers a gradual adjustment to asset allocation and risk and return over the life of a fund
  2. “Steep” – It maintains a higher allocation to stocks in real estate for a longer period of time, but as the fund nears its target date, the allocation quickly changes to bond and money markets. A steep glide path offers high risk and return, and only becomes conservative as it approaches the target date
  3. “Steeped” – This glide path has predetermined time intervals, usually 10 years, where allocations to aggressive investments are reduced. At the end of a 10-year period, for example, the fund reduces its allocation to aggressive investments and holds the new allocation mix for another 10 years.
    Like the steep glide path, the steeped glide path offers higher risk and return

 

  • In addition to glide paths, target-date funds also vary in terms of fund manager discretion
  • Some of these funds follow the glide path allocations without deviation. These passive target-date funds generally costs less but don’t adjust to changing market conditions
  • Other target date funds give fund managers discretion to deviate from the glide path allegations. These actively managed funds generally carry higher costs, but adjust to market conditions

 

 

Risks Of Target Date Funds

  • First, target date funds don’t guarantee a portfolio will meet a financial goal by the target date – after all, these funds are like other investments and are subject to market risks, including fluctuations in the stock market and changes in interest rates
  • Another risk is that target date funds provide a one-size-fits-all solution to portfolio management, but the solution might not meet every investor’s exact needs
  • And finally, both passively and actively managed target-date funds tend to have higher fees than other funds because of the built-in automatic management features
  • Despite these risks, investors looking for a hands-off approach to portfolio management can find a solution in target-date funds
  • Investors who choose this type of fund may not need to devote as much time or energy managing a portfolio as an investor using a do-it-yourself approach

 

 

And this is pretty much the gist of target date funds. They provide the investor a predetermined date at which management of their fund expires – with the hope that upon expiration, you will achieve the financial goal that you have set for yourself – whatever the case may be.

It should be noted that these funds automatically adjust asset allocations over the life of the fund. You will more likely see more daring and aggressive investments to be made in the early years – as this is a ploy to expedite the growth of the fund. But as you near your deadline, the primary goal of the fund is to preserve as much capital as it can possibly can. This is evident in switching gears as you invest more so in safer assets such as bonds.

Target date funds tend to move/allocate funds at different rates – and are known as: Linear, Steep, and Steeped (to learn the distinctions between all three, view the content above for more information). But the basis of all three are the same, take more risk in the early years and then pump the brakes on growth toward the tail end of the fund. It’s essentially mutual fund investing made automated.

I hope you have enjoyed this post and found the information to be quite useful. If you have any questions or concerns, please feel free to leave them down in the comment thread below and make sure to like and share this post.

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