Tracking the Rise of Target-Date Funds

Target-date funds (also called lifecycle funds) have become increasingly popular in recent years, especially in employer-sponsored retirement plans. More than 75% of 401(k) plans offer this type of fund — often as the default investment — and about one-third of 401(k) investors include target-date funds in their portfolios.^1–2 Target-date funds are also held in IRAs and other types of accounts (see chart).

Many investors may find these funds to be appealing because they offer what appears to be a simple investment strategy. However, they may not be as simple as they seem.

How Target-Date Funds Work

Target-date funds are hybrid mutual funds that generally include a mix of asset classes: stocks, bonds, and cash alternatives. The target date is the approximate date when an investor would withdraw money — typically the date when he or she expects to retire. Target-date funds are generally available by date. Thus, an investor expecting to retire in 2030 might choose a 2030 fund.

The further away the target date, the greater the risks the fund usually takes — a strategy based on the idea that investors with longer time horizons may have a greater opportunity to recover from potential losses. As the target date approaches, the fund typically shifts toward a more conservative asset allocation to help conserve the value it may have accumulated.

A common misconception about target-date funds is that different funds with the same date are alike. In fact, they typically won’t have the same asset allocation or investment holdings. One study found that funds with a 2020 target date had stock allocations ranging from 48% to 90%.³ The turnover rate of assets and the glide path also vary among funds. The glide path is a formula that determines how the asset mix will change over time, before (and sometimes after) reaching the target date.

The principal value of target-date funds is not guaranteed before or after the target date. The return and principal value of all mutual funds fluctuate with changes in market conditions. Shares, when sold, may be worth more or less than their original cost.

For some investors, target-date funds may offer a helpful approach to allocating assets. Be mindful that it’s important to look beyond the target date to determine whether a particular fund is appropriate based on your goals, time horizon, and risk tolerance. Asset allocation does not guarantee against investment loss; it is a method used to help manage investment risk.

Mutual funds are sold by prospectus. Please consider the investment objectives, risks, charges, and expenses carefully before investing. The prospectus, which contains this and other information about the investment company, can be obtained from your financial professional. Be sure to read the prospectus carefully before deciding whether to invest.

1) Employee Benefit Research Institute, 2010
2) Investment Company Institute, 2011
3) Morningstar, 2010

The information in this article is not intended as tax or legal advice, and it may not be relied on for the purpose of avoiding any federal tax penalties. You are encouraged to seek tax or legal advice from an independent professional advisor. The content is derived from sources believed to be accurate. Neither the information presented nor any opinion expressed constitutes a solicitation for the purchase or sale of any security. This material was written and prepared by Emerald. © 2012 Emerald.