Step # 1: Gauge Glide Path
When researching TDFs, you will inevitably encounter the term “glide path”. A glide path is a predetermined rate where a fund changes its asset allocation over time. Typically, target-debt funds start with a large percentage in stocks and gradually decline in favor of a larger weight gain on bonds as they approach the specified target date. It is important to note that glide paths can vary greatly from one TDF series to another. Visit the sponsor’s website or see the prospectus to understand how his asset allocation will change in the life of the fund, especially when you are close and in retirement.
Step # 2: Evaluate asset class
Next, “look under the hood” and determine what funds are invested. Some funds are primarily tied to major asset classes, such as U.S. stocks and advanced international markets, as well as U.S. and international government and corporate bonds. Others are mixed from emerging markets in stocks and bonds, “junk” bonds, real estate, inflation-protected securities and commodities.
Step # 3: Search Investment Methods
The primary question here is the index vs. actively managed? Some TDFs include actively managed funds that seek to exceed similar funds or market benchmarks. To do this, managers use research, market forecasts and their own judgments and experiences to buy and sell securities. Other TDF indicators are made up of funds. An index is a group of securities that represents a market or a part of a market. An index fund tries to track the returns of a market, such as the broader US stock market, or the market segment, such as short-term bonds. Over time, indexing has performed more favorably than active strategies, largely resulting in lower costs. Some active managers have performed more than peers and standards at different times, but the evidence suggests that it is extremely difficult to perform more consistently due to the high costs associated with active management. Remember, many TDFs follow a static asset allocation strategy, which means that the underlying portfolio remains the same (without glide-path changes). Some funds, however, are more strategic, changing portfolios as market conditions change.
Step # 4: Discover the risk-reward trade off
Depending on the factors described above, a TDF is subject to different types and levels of risk. In my opinion, this basically leads to a trade-off between market risk (price fluctuations due to movement in the economic market) and scarcity risk (e.g., the value of a portfolio is lower than expected and insufficient to meet an investor’s demand.) By providing the best opportunity for protection from the risk of scarcity, these securities also expose you to a high level of market risk. At the same time, the risk of deficits may increase due to high inflation and rising health care spending. It is especially important for retirees to balance market risk and deficit risk. Make sure you are comfortable with market risk levels, considering the length of your retirement, your health and other sources of income such as pensions and social security. Your retirement can be 20-30 years, so some stock exposure is important to increase.
Step # 5: Keep performance from perspective
You may be tempted to pick a top-performing target-debt fund and call it a day, but I recommend looking closely at its track record before investing. First, compare the performance of a fund with its peers over a 5- and 10-year period (or more). Usually a fund with a higher fund allocation can provide a higher return, of course, with more short-term volatility. Second, look at performance in each calendar year. Third, for better measurement, check the performance in the down market. The first quarter of 2020 will give you a better idea of how funds deal with market volatility.
Step # 6: Consider the cost
Cost is important, especially over time. In particular, compare the expense ratio, which is expressed as a percentage of the fund’s annual operating expenses average net assets. You don’t get a bill for these operating expenses because they pay directly from a fund’s income. That’s why it’s important to know what you’re paying for. The lifetime of your investment in TDF, which can probably be 40 to 60 years, low cost can give you a good chance to reach your goal and retire financially comfortable. The Target-Debt Fund simplifies the decision-making process for investors and provides a ready-made portfolio suitable for retirement planning. If, for whatever reason, you don’t want to combine a balanced, diversified investment program on your own, a TDF should be one of your considerations. If you have more complex financial needs, you may want to consider financial advice. I will explore this option in my next blog post.
Investments in target retirement funds are subject to the risk of their underlying funds. The year in the name of the fund refers to the approximate year (target date) when an investor in the fund retires and leaves the workforce. The fund will gradually shift from a more aggressive investment to a more conservative one based on its target date. Investment in Target Retirement Fund is not guaranteed at any time on or after the date of investment.
The recommendations of this fund are based on the retirement age of approximately 65 years. If you want to retire significantly sooner or later, you may want to consider a fund, including allocating resources for your specific situation.
All investments are at risk, including the potential loss of money you invest. Diversity does not guarantee gain or protect from loss. Investing in bonds is subject to interest rates, credit and risk of inflation.