It is essential for the investor to choose a suitable fund as they are putting their hard-earned money into it. The main goal is to grow the capital and earn good returns on it. Target-date funds are one such option that encourages the young investor to invest for a long duration. It manages the money by balancing between equity and debt instruments to lower risk and raise returns.
This article will help you to know the meaning of these funds, the pros and cons associated with them, and whether they are suitable for Indian investors or not.
Understanding Target Date Funds
Investors who intend to withdraw money in a specific year, typically the year of retirement, are the target audience for target date funds. As the target date draws near, the fund automatically modifies the asset allocation, shifting from aggressive (equity-heavy) to conservative (debt-heavy) options.
Key Features:
- The fund takes a glide path, progressively moving from high-risk, high-return assets (like stocks) to low-risk, income-producing assets (like bonds).
- The fund handles portfolio rebalancing, saving investors the trouble of investing in multiple funds.
- Perfect for long-term objectives like retirement, educating children, or building wealth by a certain age.
How Do Target Date Funds Work?
These funds follow an integrated approach. The working procedure is described below:
- The glide path, a preset timetable that gradually changes the fund’s asset mix, is the fundamental idea behind TDFs:
- In the early years of the plan, in order to optimise growth, the fund makes a larger investment in stocks.
- To lower volatility during the mid-life of the plan, it is gradually switched from equity to debt for lower risk and better adjusted risk.
- As the target date draws near, the fund shifts to a more conservative approach, emphasising the preservation of capital through debt instruments or liquid assets.
Advantages and Limitations of Target Date Funds
Pros:
- Automatic Rebalancing: As your target date approaches, the fund gradually modifies your asset allocation to lower your exposure to equity.
- Simplicity: Perfect for novices or people who prefer not to actively manage their investments.
- Diversification: The majority of TDFs combine debt, equity, and occasionally foreign exposure into a single product.
- Investors can maintain focus on long-term objectives like retirement or education by using goal-based investing.
Cons:
- Limited Flexibility: The asset mix has a preset glide path that may not be suitable for different risk appetites, and you are unable to modify it.
- Costlier: Because of their active management, certain TDFs are more expensive than passive index funds.
Are Target Date Funds Suitable for Indian Investors?
The points below will help you in finding the suitability of TDF for Indian investors:
1. Increasing Relevance in a Changing Financial Environment
The demand for structured long-term investment tools like TDFs is rising as India’s financial landscape changes from joint family support systems to independent retirement planning.
2. Better Investor Conduct
Emotional decision-making and market timing are frequent challenges for Indian investors. By automating allocation, TDFs lessen behavioural traps like excessive exposure to risky assets or panic selling.
3. Promotes Budgeting
TDFs encourage goal-based investing by aligning asset allocation with a target year, which may help investors stay disciplined; however, they do not inherently prevent early withdrawals, as investors can typically redeem their units before the target date, subject to fund terms.
4. Restricted Domestic Products
Few Indian AMCs currently provide genuine TDFs. The majority of options are either dynamic allocation funds without a year-specific glide path or hybrid funds with an emphasis on retirement.
5. Lack of Customization
The risk profiles and financial requirements of Indian investors are varied. TDFs might not offer the level of personalisation that certain investors need.
6. Possible Integration with EPF and NPS
TDF-like models could work well with retirement frameworks like the National Pension System (NPS) as India modernises pension reforms, providing options for a more seamless transition.
7. Extended Prospects for Young Investors
India has a huge pool of young earners, with more than 65% of the population under 35, who are perfect for target-date-based investing.
Bottomline
The conclusion can be drawn that for investors with long-term goals like retirement, target date funds are a good option. It helps in building discipline among young investors from an early age. The funds balance the risk and reward by adjusting the portfolio during the tenure of the investment. At early stages, more investment is made in equity to gain returns, and in later stages it is gradually shifted towards safer debt instruments.
However, it is essential to choose a trusted fund as there are limited options available in India.