An integral part of financial planning is saving up for retirement, your child’s education, or a significant expense planned during a specific time in the future. One of the best ways to go about this is by using a target-date fund.
What are target-date funds?
Target date funds are an effective investment strategy that aids investors to fulfill their goals of financial planning. The investor estimates the year they would require withdrawing the money and picks the fund accordingly. For example, if a 25-year-old in 2021 wants to retire at the age of 60, they can pick a fund with the target date of 2056.
Investments ranging from equities to bonds to fixed income all form a part of these funds. Usually, fund managers do not opt for alternative investments when it comes to target-date funds.
How do they work?
Like all funds, target-date funds have a set objective for their investors. Based on their financial goals, the timeline and risk tolerance are determined, and the fund manager invests in various asset classes.
These funds are rebalanced regularly. The closer the fund approaches the target date, the less risk the portfolio takes on. The portfolio is rebalanced and shifts from riskier investments like shares towards a more conservative portfolio to minimize risk closer to maturity. Typically, restructuring takes place annually.
Who should opt for target-date funds?
Anyone who has an idea of when they require a considerable sum for a specified purpose should opt for a target-date fund. An investor’s personal financial goals are the critical determinant of this decision.
A glidepath is the investment roadmap that represents the asset allocation for the fund. This keeps changing depending upon the restructuring of the asset mix. In the beginning, the fund has a higher proportion of stocks compared to fixed income, which changes as the fund approaches the target date. This representation of the mix of investments is captured in the glidepath. The investor can get an idea of the average risk in their investment by observing the glidepath.
1. Target date funds reduce the stress of financial planning. Investors generally pick a target-date fund and then leave their investments on autopilot.
2. These funds need not be monitored every minute, unlike short-term investments.
3. Owing to the long-term nature, target-date funds reduce the risk of regular market turbulence through diversification.
1. The fees for such funds tend to be on the higher side. This is because owing to the fund-of-funds nature of the investment; you have to incur the expenses of obtaining the underlying assets, as well as a separate fee for the fund manager on top of that.
2. While these funds are less riskier than some other forms of investments, they are still not entirely risk-free. There is no guarantee that investment in a long-term target-date fund will ensure the fulfillment of your financial goals.
3. No one’s financial goals are static, especially in today’s dynamic world. It is not easy to change some of the terms and conditions of these funds according to any changes in your financial goals.
Picking the right fund
It is tough to pick just the right fund for the fulfillment of long-term goals. There are a few things to consider, however, which can make this process easier:
Picking the target date: Funds are typically named after their target date (e.g., American Funds 2030 Target Date Retire Fund, Vanguard Target Retirement 2025 Fund, and State Street Target Retirement 2060 Fund). Estimating the year you might want to retire in case of retirement planning will aid in picking the best fund.
Risk Assessment: It is best to know your risk tolerance beforehand while deciding on a fund for long-term investment.
Check the expenses: Compare your options while considering the fees and other hidden expenses that you may have to make.
Keep track of the asset allocation: Ensure that the asset allocation aligns with your long-term goals.
Monitor the glidepath: Ensure that the glidepath at every stage is at a level comfortable for your personal investment goals, maintaining a balance between risk and return.
Best Target-Date Funds
Despite being among the top five growing economies, the concept of target-date funds in India is not very popular. Recently, target-date debt funds have started growing, such as Edelweiss Nifty PSU Bond Plus SDL Index Fund-2026, IDFC Gilt Index Funds, and Nippon India ETF Nifty SDL-2026. While these funds are medium-term, they are ideal for any planned expenses post five years.
The closest substitute for investors planning their retirement is the National Pension System (NPS). For financial planning purposes, investors generally opt for long-term funds that follow a concept similar to target-date funds.