The Perils of Target Date Funds

Investing for the long terms means saving up for retirement. If you’re not sure where to go, you’ve probably heard people talk about target date funds. Although they work a little differently in the UK with the pension system, the basics are pretty identical to the American system. The concept seems so simple on the surface: all you have to do is just select a competing fund, put your money there and just leave it alone. They are also called life cycle funds or age based funds.

Unfortunately, these funds aren’t as simple as they’re being billed out to be. They’re calculating when you go to retire, and then adjusting your risk allocation based on that. All this means is that they’re more likely to invest in riskier things when you’re younger and become more conservative as you get closer to retirement, when you don’t have time to make up for losses in the market.

Each fund will have different expense ratios to present, as well as different construction. Some funds will go more for index funds, while other funds like to go more for equity markets. The right fund depends a lot on your risk tolerance.

The problem with target date fund is that it encourages the investor (you) to not pay attention to your money. Anything that keeps you from paying attention to your money is something that would be best avoided as much as possible, because it’s only going to open the door to bigger problems. For example, let’s say that you choose a target date fund that is going to get conservative as you get older, but you fail to meet the target amount you’d need for retirement. You’re going to have to go riskier in order to make up the difference. If you’re watching your investments, then you would know how to do this. But on the other hand, if you are just letting the platform take care of it, you could find yourself missing out on a healthy return.

The truth is that we need active management in order to have control over our money. With the new pension freedom scheme in place, we’re now able to take our investing routine to the next level!