Target date funds: Letting time do its work

The investment options in your retirement accounts can feel overwhelming, especially with so many mutual funds blending stocks and bonds. One way to simplify your choices is by exploring different fund categories, like target date mutual funds.

Target date funds, often found in 401(k) plans, are designed to adjust your portfolio’s risk as you move closer to retirement. Early on, they invest aggressively to aim for strong returns, then gradually shift to more conservative investments as retirement nears. This built-in rebalancing takes the guesswork out of managing risk over time.

By understanding how these funds work and their associated costs, you can decide if they align with your retirement goals.

A target date fund is named for the year its investors typically plan to retire and start withdrawing their money. All you need to do is choose the fund with a date that aligns with your expected retirement year and let it handle the rest.

Funds like these are expertly coordinated by an investment manager or use an algorithm. Early on, the manager will likely lean toward investing your funds according to a more aggressive strategy that offers more potential for growth but may also have more risk. As time passes and your retirement approaches, the manager will adjust the asset mix to align with a more conservative strategy, where more of the assets are stable even if the potential for high returns is reduced.

The mix of assets in a target date retirement fund is guided by the investing concept of diversification.^* Investing in a variety of assets can offer less risk than investing 100% of your savings in a single asset, such as the stock of just one company or just one piece of real estate. With a target date fund, the manager takes care of selecting the mix of assets to invest in and the gradual transition of asset mixes over time—giving the investor the benefit of a sound risk management strategy with diversified assets.

Many investors aren't sure what their mix of assets should be, or they don't know when to shift from riskier investments to more secure ones. It can be challenging to stay on top of or even be familiar with which stocks, bonds or mutual funds truly align with your preferences for risk versus return potential. If you're new to investing and are learning the ins and outs of risk and dollar-cost averaging, these funds offer you the ability to adhere to best practices in a single fund, without having to make large initial investments.

A target date fund can be a convenient, all-inclusive way to invest that takes care of adjusting your investment risk appropriately over the years. The phrase "all-inclusive" means you don't personally need to rebalance or choose the funds periodically to adjust your risk—a single target date fund does that for you. Plus, it can allow you to offset some of the impact of inflation on your money by generating returns while also lowering risk and reducing the impact of a market shock right before your retirement.

While some investors use a target date fund for all of their invested assets, that isn't the only way forward. As you grow your understanding of investing, it's wise to talk with a financial advisor about whether using only a target date fund is serving all your goals. It's possible to use this kind of fund as a core part of your investments while also complementing that fund with other fund choices. Some investors want a more specific investment time horizon and risk tolerance, so combining target date funds with other funds can offer a more attuned investing experience aligned with your goals.

While target date funds offer a number of benefits, they might not be a good fit for every investor. Here are a few potential drawbacks to keep in mind as you consider your options:

• Higher fees. Target date funds often consist of other mutual funds. At each level, investment managers handle the activities of buying and selling stocks, bonds and other assets. That means there are fees and expenses for your portfolio at each level. As a result, all-in-one funds like target date funds can have higher costs than other mutual funds.

• Must be adjusted if your plans change. Another potential issue with selecting target date funds is that your retirement intentions can change over time. While you can transfer your money from one target date fund to another, your already invested money will have been on a different risk trajectory, which may affect how your investments grow over time. This is something to consider if you think there's a possibility you might wish to retire earlier or later than planned.

• Can alter a diversified portfolio's risk level. One other consideration is that if you invest in target date funds as well as other investments, you may or may not be hitting your optimal risk level at any given time. The idea of simplified, all-in-one investing can be nice—but especially when it comes to coordinating a wide portfolio of investments, easy doesn't mean optimal. A financial advisor can help you look objectively at how target date funds, plus all your other investments, align with your overall risk tolerance and goals.

A Thrivent financial advisor can help you navigate target date funds and other investments to align with your goals. With expert guidance, you can make informed choices and adjust your portfolio as your needs and market conditions evolve, ensuring you're on track for retirement.