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Your questions answered: Investments #2

Today, I'll be answering another investment-related question that I received from a reader like yourself. If you have a financial issue or concern you'd like to see addressed on the blog, you can let me know here.

Are target date funds effective?

In my opinion, target funds can be effective when used correctly. I would start by asking yourself the following questions:

Does the fund you've selected match your anticipated retirement date?

Or have you selected that fund because it takes on least amount of risk that still gives you the best chance of meeting and exceeding your specific goals?

Matching up your anticipated retirement date with the year on a target date fund does not take into account whether that specific fund's level of risk is appropriate for your personal situation.

As an example, let's say we have two people, both age 45 who want to retire in 15 years and pay themselves $100,000 a year in retirement income. Person #1 has $300,000 invested and is saving $3,000 a year towards their retirement. Person #2 has $900,000 invested and is saving $30,000 a year towards their retirement.

Despite being the same age and desiring to retire at the same time with the same amount of retirement income each year, the two people in our example have very different financial situations. It's unlikely that the same target date fund would be appropriate in both situations.

I'm all for the simplicity that target date funds provide, but only when you start by figuring out which one works best for you and your personal situation. That process involves a lot more thought and homework than merely matching up the date on a target date fund with your expected retirement date.