Target date funds explained

This financial product has been growing in popularity, but what is a target date fund?

A target date fund is a basket of different assets -mainly bonds and equities-  structured for a specific event in the future, such as retirement or post-secondary education. The name of target fund contains a year, for example “target fund 2025”. As it nears its date, the fund gradually shifts its asset allocation towards fixed income to preserve the capital.

Target funds are also known as “fund of funds” because they are usually made of other mutual funds or ETFs from the institution selling it.

Just like all other financial products, it has its pros and cons.

Pros:

  • Convenience: when investing in a target fund, you don’t have to manage it or figure out re-balancing.
  • Diversification: a target fund invests in a wide variety of bonds, equities and sectors worldwide. You may not be able to achieve this level of diversification on your own.
  • Starting point: target funds can be a good start for beginner investors or young adults who don’t have a lot of money to invest. This product can yield returns you also may not be able to achieve on your own.

Cons:

  • Lots of research: you will usually have to do a lot of research before choosing the right target fund for you. Because this product is made of other funds, you will need to research these too to check on their performance.
  • Gliding path or re-balancing: You will have to investigate this as well. You don’t want a fund that would become too conservative too early. On the other hand, you don’t want  a fund that becomes conservative too late either. Many people lost a lot of money in 2008 because their target date fund of 2010 was still heavily invested in equities.
  • One investment only: if you buy a target fund, you usually can’t have other investments, as these would simply defeat the purpose of your target fund.

As with all financial products, there are no guarantees that a target fund will deliver when its time is up. You could loose money.

You also need to check on the MER or TER, depending on what the fund is made of. This impacts your return. Because target funds are made of other mutual funds or ETFs that also have MER or TER, you might end-up paying underlying fees.

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