Are target date funds passively managed?
Target date funds can be actively managed, passively managed, which means investing in index funds, or a blend of the two strategies. The advantages of target date funds include simplicity and professional management.
Target-date funds are actively managed and periodically restructured to gradually reduce risk as the target retirement date approaches. Target-date funds can be riskier than most people expect, but they usually become less volatile than individual stock market index funds as the target date approaches.
Target-date funds, often a type of mutual fund, are a “set it and forget it” investment option. After participants set their contribution from their paycheck and select the funds, the asset mix in the funds automatically adjusts, slowly becoming more conservative as participants get older and closer to retirement.
Target date funds also are offered in different management styles, for example: active, blend, or index-based approaches.
In general terms, active management refers to mutual funds that are actively managed by a portfolio manager. Passive management typically refers to funds that simply mirror the composition and performance of a specific index, such as the Standard & Poor's 500® Index.
An actively managed fund means a fund manager has more involvement in the decision making, is more active in looking after which stocks and bonds go in and out of a mutual fund portfolio and when. In passively managed funds, the fund manager cannot decide the movement of the underlying assets.
One main benefit provided by target date funds is access to professional management. The managers conduct research to inform the creation of the “glidepath” strategy that the fund will use.
Well, with people living longer, critics of TDFs say that the funds leave the average retiree vulnerable to what's called “longevity risk,” the risk that you'll outlive your retirement savings. With many TDFs, by the time you hit retirement you'll have only 30% of your money in stocks.
Target-date funds are structured to maximize the investor's returns by a specific date. Generally, the funds are designed to build gains in the early years by focusing on riskier growth stocks, then they aim to retain those gains by weighting towards safer, more conservative choices as the target date approaches.
Market downturns can help target-date investors grow their retirement savings. Periods of market downturns are stressful for all investors; however, historical data shows that participants are often rewarded through higher long-term returns.
What is the difference between active and passive target-date funds?
Active target date providers typically seek to add value by making tactical asset allocation decisions on the glidepath based on changing market conditions. Most passive providers don't have the same flexibility and typically maintain the same glidepath over time.
Key Takeaways. Target-date funds provide a simple way to save for retirement. They offer exposure to a variety of markets, active and passive management, and a selection of asset allocation. Despite their simplicity, investors who use target-date funds need to stay on top of asset allocation, fees, and investment risk.
Index funds outperform most actively managed target-date funds. They are good for investors who are risk-averse and have a long time horizon. Target-date funds may be tax-advantaged, however, since they are approved for inclusion in 401(k)s. However, they require an investor to stick with one fund family.
Passively managed index funds face performance constraints as they are designed to provide returns that closely track their benchmark index, rather than seek outperformance. They rarely beat the return on the index, and usually return slightly less due to operating costs.
Fund managers of passive funds do not conduct any research to pick up stocks that can be a part of their portfolios. They imitate the index composition. For example, a passively managed fund tracking Sensex will invest in the stocks of 30 companies that make up the index in the same proportion.
Passive investments are typically associated with index funds. These include the Vanguard 500 Index Fund, SPDRF S&P 500 ETF and Vanguard Total Stock Market Index Fund.
The total on hand for exchange-traded funds and notes, along with passively managed mutual funds, totaled $13.29 trillion at the end of December, nudging higher than the $13.23 trillion held in actively managed funds, according to Morningstar.
Among the benefits of passive investing, say Geczy and others: Very low fees – since there is no need to analyze securities in the index. Good transparency – because investors know at all times what stocks or bonds an indexed investment contains.
While passive funds still dominate overall due to lower fees, some investors are willing to put up with the higher fees in exchange for the expertise of an active manager to help guide them amid all the volatility or wild market price fluctuations.
Target-date funds are designed to age with you by automatically rebalancing your portfolio from growth investments toward more conservative ones as retirement nears. Kevin Voigt is a former staff writer for NerdWallet covering investing.
Are target-date funds risky?
Target-date funds do not provide guaranteed income in retirement and can lose money if the stocks and bonds owned by the fund drop in value.
Target-date funds greatly simplify the process of keeping on top of your retirement investments. The biggest advantage of target date funds is that they handle the challenging task of optimizing your asset allocation and rebalancing your investment holdings.
The Bottom Line
A target-date fund is generally a "fund of funds," meaning that the investor is paying an extra layer of fees. Those additional fees could make the fund's actual return compare unfavorably to other options for a retirement portfolio, such as an S&P 500 Index Fund.
Automatic rebalancing: Target date funds are automatically rebalanced periodically to maintain their target asset allocation, so that swings in the markets do not throw a participant's allocation off course. Research shows that systematic rebalancing tends to improve a portfolio's long-term performance.
Target-date funds are meant as a one-stop shop for your retirement savings. But a key difference between fund brands means that target-date funds, or TDFs, may not be well-suited to all 401(k) investors — especially those close to retirement, financial experts said.
