In the world of asset allocation funds, there are basically two choices available: target-date funds, and target risk funds. They may and look very similar, but there’s one important difference: target of risk funds are static, while target date funds change over time. Let’s dig into that a little deeper.
Asset allocation funds (including target-date and target risk funds) are built to offer one stop shopping. An investor can choose one investment, but avoid having all of her eggs in one basket. How is that so? Asset allocation funds are typically “funds of funds” – they invest in a number of different underlying funds. So, in essence, an investor who picks one asset allocation fund is really investing in numerous funds. Depending on what those underlying funds are (the proportion in stock funds vs. the amount in bond funds and cash), the asset allocation fund might be aggressive or conservative.
Yes, But What’s the Difference?
So, what exactly is the difference between target-date funds and target risk funds if they’re both asset allocation funds?
Target-date funds are built with a specific date in mind. In most cases that is a retirement date, although it could also be a time when somebody will begin attending college. Target-date funds gradually get more conservative as you approach the target date. So, if the target date is 30 years away, the fund might have most of your money in riskier investments such as stocks. As time passes and you approach the target date, money gets shifted into safer investments such as bonds and cash. The idea is that you don’t want to have a lot of money in the stock market if you’re going to need it soon (if you’re about to spend the money on living expenses in retirement, or college tuition, for example).
Read more about target date funds here.
Target risk funds are different. They are designed to keep you at a certain risk level, and they won’t change over time. If you invest in an “aggressive” fund, most of your money will likely be invested in the stock market. If you want to reduce the amount of risk you’re taking for whatever reason, you’ll have to do it yourself – it won’t happen automatically in the fund. That aggressive fund will always be an aggressive fund, but you can always switch to a “moderate” or “conservative” target risk fund if you like.
There is also the issue of fees. Target date funds tend to be more expensive investments than target risk funds. Presumably this is due to the additional management (easing off the gas pedal as you approach your retirement date). However, fees vary, and some target date funds are hardly more expensive, while others are significantly more expensive than target risk funds.