In today's world, investors want convenient solutions to help
make their financial lives and investment strategies easier to
manage.
Now, thanks to an innovative and increasingly popular class of
investment products known as "target-date funds" (or "target
maturity funds") investors from all walks of life have access to
tools designed specifically to help them accomplish that goal.
Investors Seek Convenient Solutions
The investment industry has spent decades suggesting that the
best way to pursue long-term goals, such as retirement, is to
maintain an asset allocation (investment mix) that complements your
specific financial timeline and tolerance for risk.
Of course, many experienced investors regularly monitor and
adjust their portfolios with those priorities in mind. But for
people who lack the time, confidence, or resources to make
well-informed asset allocation decisions, successfully employing
such a strategy may seem easier said than done. Without an
appropriate asset allocation strategy, though, it may be difficult
to accomplish your most important goals in a timely manner. Keep in
mind, however, that asset allocation does not guarantee a
profit.
Asset Allocation in Action
The first attempt to help investors make well-informed asset
allocation decisions was the introduction of so-called lifestyle
funds. Generally speaking, fund companies offer a series of
lifestyle funds, each of which is supposed to maintain a
predetermined asset allocation. Collectively, the funds' asset
allocations range from one end of the risk/reward spectrum
("conservative") to the other ("aggressive").
But since a lifestyle fund's asset allocation is not supposed to
change, it's up to individual investors to transfer money from one
lifestyle fund to the next as goals approach and priorities change.
In other words, the responsibility for potentially complex
investment decisions is still in the hands of each investor.
Target-Date Funds Make It Simple
To address those concerns, more and more companies are now
offering target-date funds specifically designed to help ordinary
investors identify and maintain appropriate long-term asset
allocation strategies almost effortlessly. The target date in the
fund is the approximate date when an investor plans to start
withdrawing money from the fund. While the principal value of a
target-date fund cannot be guaranteed at any time, including the
target date, a target-date portfolio's asset allocation is
automatically rebalanced on your behalf over the years by
professional investment managers, generally growing more
conservative as the identified target date approaches.
In order to fully appreciate the potential benefits of
target-date funds, it helps to take a closer look at the role of
asset allocation as a guiding investment strategy.
Performance and Risk Potential
The three main categories of investment assets are stocks,
bonds, and cash investments. Therefore, your asset allocation
refers to the exact mix of stocks, bonds, and/or cash that you own.
For example, a portfolio divided equally among stock investments
and bond investments would be said to have an asset allocation of
50% stocks and 50% bonds.
That's important to remember when selecting investments for your
goals because each type of asset has unique performance
characteristics and risk potential. For example, stocks have
historically produced the highest long-term average annual returns
but also the greatest degree of short-term volatility (price
swings). Bonds, by comparison, have typically generated less
volatility but also lower average annual returns. And cash has
generally provided the lowest returns but also the least amount of
volatility risk.
How important is asset allocation? One landmark study determined
that it may potentially have a greater effect on your portfolio's
performance than the specific investments you choose. It found that
about 90% of the variability of average total returns in the
portfolios being studied was attributable to asset allocation
decisions -- not specific investment choices.1
Target-Date Funds Make it Easy
For many investors, the ultimate appeal of target-date funds is
the ease with which you can make appropriate investment decisions.
Generally speaking, the name of each target-date fund includes a
specific year, such as "2020" or "2030." All you need to do is
choose a fund named for the year closest to the year of your goal.
From that point on, professional investment managers handle the
investment decisions, such as selecting individual securities for
the portfolio and rebalancing the asset allocation so that it
becomes increasingly conservative the closer you get to your
goal.
Can investing really be that easy? With target-date funds, the
answer may be yes.
