If you are currently participating in an employer sponsored retirement plan or maybe you’re looking at options for your own self managed accounts like a brokerage account or IRA, you’ve probably seen some options for Target Date Funds or Allocation Funds. A lot of people don’t know which one is right for them. They both have advantages and disadvantages. Let’s take a closer look at them.
Target Date funds are mutual funds or exchange traded funds that use future dates as the time horizon you are targeting to retire. For instance, if you are 30 years old today, your target retirement age will be somewhere around 35-37 years in the future from today’s calendar year. Most target date funds are typically set up on 5 year increments, so you would choose 35-40 years in the future. Based on the year you choose, the fund will allocate a certain amount to stocks and a certain amount to bonds. The farther away you are from the date of the fund, the more the fund will allocate towards stocks since you have a longer time horizon you need to be in more growth oriented investments. An important feature of target date funds is they re-allocate the mix of stocks and bonds as you get closer to your retirement age. It’s kind of like autopilot, you choose when you plan on retiring and it will make changes to the allocation for you. They may be a good option for those that do not want to monitor their allocation in their company sponsored retirement plan or IRA.
Allocation Funds or Style Funds are mutual funds or exchange traded funds that are focused on a certain mix of stocks and bonds they maintain without changing automatically. When you choose an allocation fund, they may have a description in the fund name like Income, Moderate, Growth, Growth and Income, Aggressive Growth, Global Growth, etc. The name of the fund typically tells you the style of the fund or how it is allocated between stocks and bonds. For instance a Moderate Allocation may be 50-70% stocks, and 30-50% bonds. A Growth or Growth and Income Allocation may be 70-90% stocks and 10-30% bonds. Aggressive Growth or Global Growth may be 90-100 % equities and will have more international exposure to their allocation, as well. Allocation funds vary slightly between fund families, so you have to look at their fact sheets or prospectus’ to know exactly how the funds are invested. The nice thing about allocation funds is that they have a mix of stocks and bonds to fit your style. If you’re younger and have a lot of time until retirement, you can choose an Aggressive Growth fund and know you will be 90%-100% in stocks. On the flip side, another feature of allocation funds is that you may be comfortable being more aggressive at an older age, so you can choose an aggressive allocation and know how you’re invested. Allocation funds are good for those that tend to be more aggressive for their age versus a target date fund, because the target date fund may automatically move them to a moderate allocation when they get within 5 years of retirement when they want to be more aggressive with their retirement account. Allocation funds may be better for those that want a little more control over their investment style.
Those are the main highlights on how these types of funds typically operate. There are some additional things to keep in mind when considering Target Date or Allocation Funds. The Target Date funds sometimes have a slightly higher fund expense due to the funds being actively managed and reallocated by the fund managers. Additionally, I always try to look at the different dates in a fund family series to see how the fund is allocated at different increments, so I have an idea of how the fund will allocate in the future. Some target date series are more conservative or more aggressive at different points. You still have to do a little homework to make sure the target date fund will fit your investment style as you get closer to retirement. A disadvantage to the Allocation style funds is that you have to make sure you understand your risk tolerance and understand how the fund is allocated to meet your risk tolerance. You may be a 55 year old who plans on retiring at 67, but you have a fairly high risk tolerance, so you want to be more growth focused. Some Growth Allocations may be closer to a Moderate Allocation with only 70% stock allocations because that’s how that mutual fund company chooses to call that style allocation. In that instance, since you have a higher risk tolerance and are wanting more growth, you would need to choose the Aggressive Growth style in that fund family that is 90% in stocks to get the more aggressive allocation. Additionally, you will also have to make changes in the future as needed when you get closer to retirement because allocation funds don’t change their style over time. You would have to change your fund when you get closer to retirement and want to be more conservative.
One of both options may be a good fit for your company sponsored retirement plan. No matter which option you choose, you can always elect to work with a Financial Planner or Advisor to help you make these choices. You may have access to an advisor within your company sponsored plan, but if you don’t or they are not helpful, you can always reach out to an Advisor or Planner to help you make the best decision.