I love automation and I try to incorporate it in most aspects of my life.
Similar to developing niche content websites and then letting them grow and bring in revenues on auto pilot, investing in target date retirement funds allows the investor to watch their money grow slowly and steadily over time on auto pilot.
Target date retirement funds are mutual funds that invest in various investments that are suitable to one’s general long term investment objectives based on their target retirement date. As you move closer to retirement, the manager of the target fund reallocates the investments to remain suitable based on your target retirement date.
If that sounds confusing, consider this scenario. Before target date funds were introduced, or even now considering that you are not using them, the prudent long term investment approach would be to invest heavily in stocks when you are younger, and move toward more stable and secure investments such as bonds and other fixed income funds as you get older.
The idea behind this asset allocation method is that when you are young, you have a bigger appetite for short term risk since your investment horizon is long term in nature. Investment horizon refers to the amount of time you are invested in the market before you start drawing from your investments (typically during retirement).
The longer your investment horizon is, the more you can afford to withstand the short term ups and downs of the stock market, considering that your investments in the market will net you positive growth over the long term.
As you near your retirement age, your investment horizon shortens and you typically take some of that growth and reallocate it out of stocks into investments that are less prone to risk, or fluctuation in the short term. At least that is the idea.
For example, if you are 30 years old today and plan on retiring at 60, you want to invest in a 30 year target retirement date fund. Considering it is 2011, the fund you want to invest in will likely be titled XYZ 2041. The XYZ is the investment company (i.e. Fidelity). The 2041 is your target retirement year (2011 + 30 years to go till you reach 60 = 2041).
There used to be two ways to manage your investments / asset allocation in the past. You would either do it yourself or engage a financial planner to do it for you. However, the introduction of target retirement date funds has automated this process.
There is still a manager who is equivalent to a financial planner, but the difference is that the manager manages the entire fund, which is comprised of investments from several other investors just like you.
Morningstar, a long standing and reputable source in the world of money and investments published a research report on target date retirement funds.
The report shows that Vanguard and T. Rowe Price are the best companies to invest with to simplify asset allocation and management of your money. Funds of both are available in most 401k and IRA plans. Fidelity is another big name which I am surprised was not in this report.
These companies / brokerage firms do not charge a commission fee, thus further maximizing your total return. For whatever reason, if you rather opt for a paid service, this report suggests you invest with American Funds. I have heard a lot of good things about American but cannot speak about them from personal experience.
Personally, I have the auto reallocation / rebalance option enabled in most of my investment accounts. I have a good chunk invested in a target fund as well. I do have a few other accounts that I use to trade on my own mainly on speculative investments.
By investing in target retirement date funds, you are allowing experienced professional fund managers grow your investments while steadily decreasing the level of risk in your portfolio as you approach your retirement date.
What do you think of target retirement date funds? Are you wholly, partly or not invested in them? What other advice / suggestions do you have for our readers?Previous: Paying Self Employment Taxes on Your Business Earnings