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Target-Date Funds: Simplifying Your Asset Allocation Strategy

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 "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.

1Source: "Does Asset Allocation Policy Explain 40, 90, or 100 Percent of Performance?" Financial Analysts Journal, January/February 2000.

Content is provided by Wealth Management Systems Inc. as a service to Wells Fargo. Copyright © 2021, Wealth Management Systems Inc. All rights reserved.