Target date funds: The easiest way to start saving for retirement

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Retirement target date
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Do you feel like investing is too complicated to understand sometimes? Target date funds are one way take the confusion out of investing and put the power back in your hands so you can have a financially secure retirement.

In this article, we’ll take a look at what target date funds are and why money expert Clark Howard likes them. We’ll also explain how you figure out your optimal (i.e. “target”) retirement date and walk you through how to open a target date fund.

Here’s what you need to know about target date retirement funds

Confused about target date retirement funds? Don’t be! Target date funds are specifically designed to be an investment product that makes investing super-easy.

“If the alphabet soup of 401(k)s, IRAs and 403(b)s is too much for you, just keep it simple,” money expert Clark Howard says. “With target date funds, you don’t have to do a thing other than invest your money. It’s the ultimate in ‘set it and forget it’ investing and could be the best and easiest investment choice you ever make.”

Target date funds: Table of contents

What is a target date fund?

A target date retirement fund is a simple investment portfolio that’s typically made up of stocks and bonds in a specific ratio that changes as you age.

All target date funds are identified with a specific year in their name. They’re typically divided into five-year increments (2040, 2045, 2050, etc.) and they’re available for investors to buy with a retirement date in mind that’s as close as five years down the road to as far out as 40 years down the line at any given time.

Understanding what’s in a target date fund

It’s widely accepted that the younger you are, the more risk you can afford to take with your money in order to maximize long-term returns. Putting your money in the stock market, which is volatile by its very nature, is an ideal way to accomplish this. So target date funds initially put your money heavily into the stock market in your early years.

But the closer you get to retirement, the more you should be thinking about preserving your capital rather than aggressively growing it. Bonds are an ideal way to accomplish this. They generally offer lower returns than stocks but don’t have the crazy ups and downs commonly associated with the stock market.

So, as you age, the fund manager of your target date fund will automatically add more bonds to your investment portfolio while simultaneously reducing the amount of stocks you own.

While you’re probably familiar with the idea of the stock market, you may not be as familiar with the bond market. So let’s take a moment to explain.

“Bonds are where you’re kind of like the bank lending somebody money,” Clark says. “When you buy savings bonds, you lend money to the federal government. With corporate bonds, you lend money to companies. And when you buy municipal bonds, you’re lending money to cities, counties and states.”

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Again, the beauty of a target retirement fund is that it doesn’t involve any mess or fuss on your part. When you open a target date fund, the fund’s manager allocates your money. You don’t have to know anything about the ideal stocks-to-bonds ratio for your age; it’s all done for you!

However, we want to emphasize this point: You’ll never be completely out of stocks with a target date fund. Why not? Because you never want to outlive your money. You always need at least some exposure to higher rewards (and risks) of the stock market.

If you went 100% into bonds as you approached retirement, your money wouldn’t really grow and would eventually get eaten up by inflation. That’s a sure recipe for a lean retirement and possibly being broke during your golden years.

How do I figure out my target retirement date?

Determining the “target” part you want for your target date fund is easy. It all starts with asking yourself a couple of simple questions:

  • What do you want out of life?
  • When do you want to be able to stop working?

Sure, there are a lot of retirement calculators out there — including this one from Vanguard — that can help you give you some insight on these questions. But nobody knows the right answer other than you!

Let’s play around with some real-world numbers to drive the point home.

Say you expect to retire at 70 and you’re 40 years old now. Just subtract your current age from 70 to figure out which target date fund you’d want.

In this example, you might buy a target date fund for 30 years in the future — such as a 2050 target date fund. If you want to retire in as soon as 15 years, you might buy a 2035 target date fund, instead.

Where can I open a target date fund?

Discount investment houses like Charles Schwab, Fidelity, and Vanguard all offer target date funds. You just select the year that’s closest to your expected date of retirement and pop your money in.

Vanguard Target Retirement Funds

  • Investments: A combination of stocks, bonds and cash equivalents
  • Years available: 2025, 2030, 2035, 2040, 2045, 2050, 2055 and 2060
  • Expense: Between 0.13% and 0.15%
  • Minimum investment: $1,000 for target date funds

Fidelity Freedom Funds

  • Investments: A combination of stocks, bonds and cash equivalents
  • Years available: 2025, 2030, 2035, 2040, 2045, 2050 and 2055
  • Expense: Between 0.1% and 0.75%
  • Minimum investment: No minimums to begin investing in target date funds

Schwab Target Retirement Funds

  • Investments: A combination of stocks, bonds and cash equivalents
  • Years available: 2025, 2030, 2035, 2040, 2045, 2050, 2055 and 2060
  • Expense: 0.08%
  • Minimum investment: No minimums to begin investing in target date funds

Final thought

Too often, investing can seem so complicated that you risk shutting down and not doing anything to prepare for your retirement — or you might panic and feel the need to hire someone to guide you.

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A target date fund is the antidote to that kind of mental muddle. It’s the ultimate in “set it and forget it” investing!

More personal finance stories on Clark.com:

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