When saving and investing for retirement, we all want effective solutions that are easy to understand and easy to manage. Target date funds are a type of investment solution that were built for retirement investing.
Target date funds change their asset allocation within the fund over time according to the fund’s “glide path”, which provides more stability to your portfolio as you get older and need to start withdrawing funds to supplement your income.
If you are looking for a quick overview on target date funds, check out the video below featuring Evermore Chief Investment Officer, Brian See, CFA. If you are looking for additional details and other resources, read on!
Features: Asset Allocation
Target date funds are similar to asset allocation funds, which are also sometimes referred to as balanced funds, (balanced funds typically refer to asset allocation funds that are 50% equities and 50% fixed income). Asset allocation funds are funds that hold more than one category, or “class”, of investments.
The two most common classes of investments are equities, or “stocks”, and fixed income, or “bonds”. When we talk about the “asset allocation”, what we really mean is the mix. What is the mix, or asset allocation, of these investment categories in a portfolio.
Asset allocation funds come in a variety of asset mixes.
Here are some examples of common asset allocation funds:
- a 90/10 fund is a fund that holds 90% equities and 10% fixed income
- a 70/30 fund is a fund that holds 70% equities and 30% fixed income
- a 50/50 fund is a fund that holds 50% equities and 50% fixed income
Some asset allocation funds can hold other asset classes such as commodities, private equity, real estate, or even cryptocurrencies.
Different asset classes have different risk/return profiles. That means that, historically speaking, they exhibit patterns of behaviour over time resulting in particular long term return and volatility metrics.
Equities for instance, over the long run, provide a higher average return than fixed income. However, equities are more volatile. The returns in any given year can be expected to be more varied, in other words more up or down by a wider margin, versus the returns from fixed income.
Combining asset classes together in particular ways can strengthen the risk/return profile of an investment portfolio, and asset allocation is at the core of building efficient investment portfolios.
Target date funds are also structured with asset allocation at their core, but unlike regular asset allocation funds that have a frozen allocation, target date funds use the “glide path” to determine the optimal allocation for a specific time horizon.
Diversification can refer to the asset allocation, but when we talk about diversification within an asset class that refers to the variety of individual investments within that class.
Diversification is another important factor in investment success. Diversification is how you lower your investment risk. If you just hold one company’s stock for instance, your entire portfolio would be tied to the performance of that one company, so if it goes out of business, you could lose all your money. That’s a lot of risk.
There are two ways to diversify:
- You could try and pick several investments you think would provide the right type of diversification (stock picking), or
- You could just use an investment that matches an index – in other words, investing in the market itself.
Research has shown that overall index investing outperforms stock picking, which is why the Evermore Retirement ETFs are index based.
If you are interested in digging deeper into research in support of an index-based approach, check out this white paper from index investing pioneer, Vanguard:
Features: The Glide Path
It’s the glide path that makes target date funds different from regular asset allocation funds.
In a target date fund, the glide path determines what the asset allocation should be at any given point in time. The asset allocation isn’t frozen in place, it changes in accordance with the fund’s target date.
For example, the Evermore Retirement 2050 ETF has a target date of 2050 and is built for somebody that expects to retire around that year, 2050. That’s just under 30 years away. With that long time horizon ahead, a portfolio should have more equities in the mix to take advantage of the better long term return profile of global stock markets. But as we move closer to, and then through, that date, we increase the percentage of fixed income in the portfolio.
Why are these features important?
The starting point for any investment decision is to ask – what is my goal for this money?
Retirement is a very different kind of goal versus saving for a vacation, for example. With a vacation, it has a fixed price and a specific time in the future. If you wanted to take a vacation next year and it was going to cost $2,500, you wouldn’t take $2,500 and put it in the stock market which could be down in value over any given single year. You would take that $2,500 and put it in something with a virtually guaranteed return, a savings account or GIC, so you know the amount will be there when you need to pay for your trip.
Retirement on the other hand starts out as something that is decades away. You put money away and invest it over time, and then when you reach retirement, there are additional decades of somewhat flexible withdrawals. Because investing for retirement, and then spending during retirement, stretches over many, many decades, the time you have gives you an incredible advantage to grow your money through compounding while providing the ability to absorb the year-to-year fluctuations of equities to capture the superior long-term growth the stock market provides. As you get closer to retirement and enter the withdrawal period you have less ability to absorb the ups and downs of the market, so by mixing in fixed income, you are adding stability to your retirement portfolio.
What this all means is that your asset allocation should be different depending on the time horizon of your goal. This approach to selecting the most appropriate investments is called “Goal-Based Investing”. Read our blog article on goal-based investing here.
How do target date funds work during retirement?
By now you’ve learned how target date fund work when you are saving and investing for retirement, but you might be wondering: what happens during retirement?
When you are enjoying your retirement, it is common to have to draw on your investments to supplement your income from other sources, like the Canadian Pension Plan (CPP) and Old Age Security (OAS).
Target date funds solve the problem of figuring out what to sell in a portfolio when you need your money.
When you hold several different investments and need funds for retirement, now you are forced to try and pick and choose what to sell, and what the repercussions will be for your overall portfolio. With target date funds, you just sell the number of units equivalent to the funds you need, and that’s it. Your portfolio remains exactly balanced to your time horizon.
Selecting a Target Date Fund
Bottom line, target date funds provide an easy way to invest for retirement. Choosing your target date fund is equally easy.
The name of any given target date fund typically with contain a year, like in our Evermore Retirement 2050 ETF example above. Target date funds are built so that you select the target date fund that is the closest to the year you expect to retire. Because nobody has a crystal ball, target date funds are typically issued in five-year increments.
To explore the various Evermore Retirement ETFs, click here.
Why are Evermore Retirement ETFs so special?
Evermore Retirement ETFs are the first target date ETFs in Canada. Before Evermore Retirement ETFs, target date funds were only available in select employer sponsored plans or in overpriced mutual fund structures.
Evermore’s highly experienced and professional portfolio management team has built our Retirement ETFs using a thorough, statistically tested process examining the entire universe of Canadian and US listed ETFs. Our research has shown that there isn’t a single provider that offers the best alternative across all investment classes and geographies.
The Evermore Retirement ETFs hold low-fee and highly liquid ETFs from industry leaders Blackrock, BMO, and Vanguard. Other target date funds only use their own proprietary funds.
Evermore has brought target date investing to everyone, and they are available through any direct investing account or through IIROC licensed advisors cross Canada.