Investing has been made easier by target-date funds by providing the investors with a one-stop solution for their investment needs. But along with its pros comes its cons. Mentioned below are some pros and cons to consider before you invest in target-date funds:
Excellent For Getting Started:
Most of the companies are doing away with the pensions and thus the stress related to saving during retirement is affecting individuals. The main problem behind this is that most of the people are not aware of the ways of placing together a portfolio that is well allocated. Target-date funds are believed to offer a great start for those who are not much familiar or are financially ignorant investors. Target-date funds are considered as excellent launching point for young investors who have just started to invest. They will aid you in saving and investing for a long-term by offering a portfolio that will be suitable for everything for a particular date out into the near future. Even the most knowledgeable investor should be aware of when to start off. But if you have any recent goals like saving for a new home, then you should know how to make use of such funds.
A target-date fund is designed in such a way that you will be able to invest in various mutual funds. Thus investors will be instantly accessing varied asset classes as well as market capitals. Almost each and every target-date funds will be holding small, medium and large capital as well as domestic and international stocks, bonds such as corporates, junks and treasuries along with some alternatives like trusts for real estate investments. As a result of this, portfolio will have a scope for complete range of investment under one investment tool.
If you wish to build your portfolio with various underlying mutual funds and put them in any target-date tool on your own, then the least initial investment could make you spend $10000. But with the aid of target-date funds, the least amount can drop off to $100 and you will also have access to every asset class.
In early days, target-date funds had many fees. Investors used to pay management fee apart from the fees for the underlying mutual funds. But these days, a roll-up structure is used for the fee by many sponsors. In this structure, only a single fee is included. With the blooming assets, most of the sponsors have their portfolio holdings shifted to larger as well as cheaper institutional share classes. Fees on any target-date fund costs only around 0.70% in a year.
One of the greatest disadvantages of target-date funds to investors are tax inefficiency. Individuals who will buy these funds outside an IRA or any qualified plan will understand the capital gains. Taxes related to capital gains will also be triggered regularly. This happens when shares of those funds which performed well in a target-date portfolio are sold and then moved to the shares of those funds which have not well performed. So to avoid such problem, target-date funds are mostly used in all those retirement plans that are tax deferred.
One assumption is made by the target-date funds that the younger individuals will be taking risks willingly. But that is not always true. Two of the worst recessions in the US history have bookend today millennial. So many people are afraid of investing in sticks and thus prefer saving more as well as minimize their risk. If you consider using any target-date fund, then at first have a look at its allocation from the same family of fund that will become mature or already matured. It will aid you in determining if the target-date funds that you are selecting for investment suit your risk tolerance at this target date.
Excessive Expense Ratio:
Target-date funds will be often charging excessive fees than any other types of mutual funds. This is because such funds actually will be passing through some fees that will be charged by those underlying fund options that hold the fund and its individual management fee. So some of the target-date funds come with a fee that you have to pay for any underlying mutual fund along with another fee in order to manage the funds. It has found that the average annual fee of target-date fund is more than 1%. This may decrease the return that has been posted by this fund. Investors who overlook these target-date funds and directly invest in some underlying funds can easily avoid these fees. But they have to manually relocate the funds to match the path of any target-date fund.
Lack Of Complete Diversification:
When you select any target-date fund from a particular company, you will only be able to view that company’s funds as the holdings. It would not allow investors to pick up and select the best one for each and every particular asset class. This will make way for only a similar style of investment across several underlying mutual funds. Target-date funds have various stocks as well as bonds but there is no exposure to any commodity, infrastructure and precious metals. Investors need to include all these assets to attain complete diversification.
So a little research will let you understand how to invest in target-date funds effectively.