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Investing

September 16, 2014

Should you consider a target-date fund?

If managing your own money for the next 30 years or more seems like a daunting challenge, a target date fund (TDF) may be the solution.

You’ve opened a registered retirement savings plan (RRSP) or joined the company-sponsored savings plan and you’re making regular contributions. But that’s only the first step on the road to achieving your retirement savings objectives. To reach your destination successfully, you have to invest your money effectively over time. But if managing your own money for the next 30 years or more seems like a daunting challenge, a target-date fund (TDF) may be the solution.

What is a TDF?

A TDF automatically resets the asset mix of stocks, bonds and cash equivalents in your portfolio in relation to a selected date closest to the date you plan to retire. The closer you get to the maturity date, the more your fund will be weighted towards bonds and cash and away from stocks. This is because your investment will have less and less time to recover from any stock market volatility you may encounter, which leads many investors to prefer a more conservative approach as retirement nears.

How to choose a target date

To select the most suitable fund, all you have to do is answer one question: When do I plan to use the money?

A 25 year-old man who plans to retire at age 65 will likely choose a fund dated 40 years out. While his contributions may initially be heavily weighted towards equities, the asset mix will shift over the course of his career. By his projected retirement date, the equity component will be reduced significantly.

You can include a TDF in your individual RRSP, or choose to invest in one through your workplace plan. Industry figures show that in 2012, TDFs were the most popular default option selected by group retirement plan sponsors for investing the contributions of employees who did not make their own investment selections.

Different types of TDFs

Despite having a common maturity date, TDFs can have significant differences. For example, how and when the asset mix transitions from mostly equities to a higher fixed-income component (called the “glidepath”) can vary dramatically among funds. The mix of individual securities in each fund may also vary considerably.

If you are uncomfortable with risk, you may want to look at a TDF that offers a guaranteed maturity value. Some funds also offer the opportunity to lock in a specific asset mix (such as 25% equities, 75% fixed income) to extend past the target date and into your retirement.

Whether you decide to invest all or part of your retirement savings in a target-date fund is a personal decision. It’s a good idea to discuss your strategy with your financial advisor.

Professional management

Investing in a TDF ensures you have a professionally managed and diversified portfolio. A TDF may also give you access to niche asset classes that may reduce portfolio volatility, such as infrastructure and real estate.

However, that doesn’t mean you can completely “set and forget” your retirement savings until it’s time to cash in your chips. You should review your retirement projections with your financial advisor annually to ensure they are still realistic. You may discover that you need to contribute more or work longer to finance the standard of living you’re looking for in retirement. 

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