Are target date funds better than index funds?
Key Takeaways. Index funds offer more choices and lower costs, while a target-date fund is an easy way to invest for retirement without worrying about asset allocations. Index funds include passively-managed exchange-traded funds (ETFs) and mutual funds that track specific indexes.
Funds may get too conservative too quickly
If the fund moves too much money into bonds too quickly, it could severely hit your potential retirement income. And with many seniors living more than two decades after they retire, retirees may need the extra growth provided by stocks.
A target-date fund is generally a "fund of funds," meaning that the investor is paying an extra layer of fees. Those additional fees could make the fund's actual return compare unfavorably to other options for a retirement portfolio, such as an S&P 500 Index Fund.
Key Takeaways. Target-date funds provide a simple way to save for retirement. They offer exposure to a variety of markets, active and passive management, and a selection of asset allocation.
Target-Date Funds Had Enough Equities
However, the highest stock market gains came during the middle five years, when almost all the target-date funds owned more equities than the balanced funds. Also, as the balanced funds posted stronger returns over the trailing 10 years, the timing argument fails on that account.
Remember, the growing popularity of target-date funds doesn't mean they're foolproof: All investments carry risks, and target-date funds are no exception. But for many investors, the one-stop convenience makes target-date funds the right choice.
Even if the market corrects just before retirement, they may still come out ahead of a target-date fund because they participated in more growth during the rest of the period.
The quartiles of funds that generated an average yield of 3.4% and 2.7% devoted an average of 16.6% and 15.1% of their fixed-income portfolios to high-yield bonds. The quartiles of funds that yielded an average of 2.4% and 1.9% held just 5.6% and 3.9% of their bond sleeves in high-yield bonds.
Target-date funds can be a helpful tool to reach retirement without having to make any investment decisions. If they help you invest and stay invested throughout your career, they can be a great tool. But investors, particularly retirees, should explore all their options to ensure a target-date fund is right for them.
A target-date fund's portfolio mix of assets and degree of risk become more conservative as it approaches its objective target date. Higher-risk portfolio investments typically include domestic and global equities.
What are the disadvantages of target-date funds?
Well, with people living longer, critics of TDFs say that the funds leave the average retiree vulnerable to what's called “longevity risk,” the risk that you'll outlive your retirement savings. With many TDFs, by the time you hit retirement you'll have only 30% of your money in stocks.
"It depends on your needs." But no matter how many years are left in a target-date fund, the glide path will be gradual. If you need to sell a target-date fund at any time, you shouldn't have to pay exit fees. But if you invested in a taxable fund, there may be tax penalties for withdrawal.
If you invest in target-date funds, that should be the only investment in your 401(k). Don't make the mistake that so many 401(k) holders make and try to use them to complement other funds. They aren't designed for that.
Diversification is an important factor, and you'll want to balance having too much in one type of asset. For example, many experts recommend having an allocation to large stocks such as those in an S&P 500 index fund as well as an allocation to medium- and small-cap stocks.
Nothing special happens with a Target Retirement Fund when it reaches its target date. The fund doesn't stop investing, and you don't need to take your money out of the fund. The gradual move from stocks to bonds simply continues.
- 6.34% MassMutual Select T. Rowe Prc Ret 2025Fd MMTFX.
- 6.25% T. Rowe Price Retirement I 2025 Fund TRPHX.
- 6.17% T. Rowe Price Retirement Blend 2025 Fund TBLEX.
- 6.07% T. Rowe Price Retirement 2025 Fund TRRHX.
- 6.00% Vanguard Target Retirement 2025 Fund VTTVX.
Investors who are looking to retire around 2050 can use a target-date fund like FIPFX in their HSA. This fund will automatically adjust its allocation of stocks and bonds to become more conservative as the target date nears.
Index funds outperform most actively managed target-date funds. They are good for investors who are risk-averse and have a long time horizon. Target-date funds may be tax-advantaged, however, since they are approved for inclusion in 401(k)s. However, they require an investor to stick with one fund family.
“A larger account, a more sophisticated or experienced investor, can benefit from a managed account which might take more, or less, risk than an age-based TDF. For smaller or start up plans, a TDF choice is a good one for inexperienced plan participants who might opt out of having to choose a managed fund.”
How much can you earn over time? Despite its relative safety, the S&P 500 is also a powerhouse. Even small amounts of money -- invested consistently -- can go a long way over time. Historically, the index itself has earned an average annual return of around 10% per year.
What is the minimum investment for target-date funds?
Each fund is designed to manage risk while helping to grow your retirement savings. The minimum investment per Target Retirement Fund is $1,000.
The genius of target-date funds is that they harness that natural tendency toward inertia but they do so for the good. They invest in an age-appropriate asset mix, and they gradually become more conservative as the investor gets closer to needing the money.
Index funds are a popular choice for investors seeking a low-cost, diversified, and passive investment strategy. They are designed to replicate the performance of financial market indexes, like the S&P 500, and are ideal for long-term investing, such as in retirement accounts.
You have to think of what funds comprise the target fund. You will probably have international and bonds along with the total market, so it is not a great comparison with the S&P 500 by itself. If you want more diversity and hold each fund separately your return will be lower than just the 500.
|Market share, 2021
|T. Rowe Price