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Target-date funds are the one stop shopping of the mutual fund world. These funds go by different brand names such as Freedom (Fidelity), Target Retirement (Vanguard) Retirement (T. Rowe Price), LifeCycle (John Hancock) etc. but each one is designed around a set year such as 2020 that is the approximate year the investor is looking to retire at.
The further away the target date, the greater the risks the fund usually takes – a strategy based on the idea that investors with longer time horizons may have a greater opportunity to recover from potential losses. As the target date approaches, the fund typically shifts towards a more conservative asset allocation to help conserve the value it may have accumulated.
This easy to understand concept (I will retire in the year 2020 so I will invest in the fund with 2020 in the name) helps explain the rapid growth in popularity of these funds especially in 401ks and other retirement accounts.
Now here are the common mistakes:
One) Buying more than one fund at a time. We have all heard the saying, diversify, diversify, diversify so it will probably not come as a surprise that the first mistake listed is diversifying too much by buying more than one target date fund such as the 2010, 2020 and 2030 funds. Every target date fund is made up of a combination of holdings (U.S., international, conservative, aggressive, etc.) and is designed for someone retiring on or around a set year. If you buy the 2010, 2020 and 2030 funds, you have essentially just purchased the 2020 fund (the average of 2010, 2020 and 2030).
Two) Thinking the fund will not lose money when it get closer and/or hits the target retirement year. Just because you stopped working, doesn’t mean your money can stop working for you. Target date funds are designed to continue to help your money keep pace with inflation and grow and this means they can and likely will experience losses at some point before or after your retirement year. For example, according to Morningstar during 2008, Fidelity Freedom 2010 lost 25.32%, Vanguard Target Retirement 2010 lost 20.67% and the T. Rowe Price Retirement 2010 lost 26.71%. All of these losses occurred just two years before the target retirement date.
Three) Jumping from the target date fund of one mutual fund family to the same year target date fund of another mutual fund family. Every mutual fund family organizes their target date funds with slightly differently concerning how aggressive the funds are when retirement is far away, how and when the funds become more conservative as retirement gets closer and how conservative the fund is at the actual year of retirement. Jumping from the 2020 fund from company A to the 2020 fund from company B is similar to changing doctors and prescriptions while the old prescriptions are still in your system.
Four) Not being true to yourself as it relates to being more aggressive or more conservative than others of your same age. It doesn’t matter if losing one penny makes you break out in a sweat or if you are the type of investor that puts it all on black, you will both be invested exactly the same way if you buy the same target date fund. If you want a fund that is more conservative pick one that is closer to the current year, the opposite is true if you want one that is more aggressive.
