TDFs are extremely helpful for passive investors who simply want to put money away for their retirement and not worry about it. The TDF structure takes more risk in the beginning of the investment period, allowing investors to chase growth returns while they still have a long time left before retirement. By concentrating volatility in the beginning of the term structure, a TDF ensures that the investor will have cash flow instead of capital growth when retirement is near.
But before diving into a target-date fund, it’s important do some due diligence and ask your provider these key questions.
1. At What Age Should I Expect to Retire?
So when approaching a TDF investment, you need to honestly ask yourself, “At what age do I expect to retire?” Then you need to assess if your estimate is accurate by using an investment tool or advisor. Once you confirm that your age target is realistic, then you can select a TDF that aligns with your retirement goals.
2. Global Investments or U.S. Investments?
Global investments allow for regional diversification that U.S. investments do not offer. Diversification is the only “free lunch” known in the investment world as it allows investors to mix different asset classes to create a stable risk-to-return ratio. However, U.S. investments are coupled with the economic situation in the U.S. Thus if the U.S. is underperforming the rest of the world, it is likely these investments will underperform as well.
3. How Much Risk Can I tolerate During Each Phase of the Strategy?
One TDF might invest in only U.S. small caps during the risky phase, and then rotate into U.S. T-bills, while another might invest in S&P 500 stocks and rotate into corporate bonds. These strategies will create different risk-to-reward profiles that each investor must judge for themselves.
The Bottom Line
- When do I want to retire?
- Do I want global diversification?
- How much risk am I willing to accept in the short term? In the long term?
By answering these questions honestly and with the help of a financial expert, you might find that the right TDF becomes the perfect tool for planning a stable retirement future.
