Visualizing Target Retirement Date ETFs

by on August 15, 2012

The rapid development of the exchange-traded fund industry has brought to market some of the most useful and intriguing products for all walks of investors. With more than 1,400 ETPs offering exposure to just about every asset class, investment strategy, and developed and emerging economy, the potential portfolio combinations are endless. Although investors can dip into some of the more complex and intriguing funds, most choose to select a number of ETFs that will allow them to build a well-diversified portfolio. But thanks to the innovativeness of ETF issuers, there is now an entire line of products that takes this strategy to the extreme, offering access to a complete portfolio through a single equity ticker [see also How To But The Right ETF Every Time].

A Closer Look

Enter target retirement date ETFs, the ultimate in passive, buy-and-hold investment strategy. To pick which of these funds is right for you, investors must simply select the ETF that corresponds to his or her intended retirement date (e.g. 2030 fund), the rest is left to the ETF’s manager. These hands-free portfolios are essentially designed to shift asset allocations with an investors’s changing risk profile. For example, as an investor approaches his or her retirement, a higher allocation will go to fixed income products, while a younger investor would have a heavier weighting towards equity exposure.

Here’s a look at six iShares Target Retirement Date ETFs and how these funds change over time:

As depicted graphically above, the S&P Target Date 2040 Fund (TZV) has a much higher allocation to domestic and international equities, while the S&P Target Date 2015 ETF (TZE) has a larger weighting in fixed income. Logically, this makes sense since an investor with a target date of 2040 is likely much younger than someone who wishes to retire in 2015. And, as such, a person who has a longer time horizon over which they are able to recover value in event of major losses can have more exposure to riskier asset classes, like stocks, which may be more volatile but could provide a more meaningful return. But for those who plan to retire in the near future, a low risk tolerance is more appropriate since these individuals have less time to recuperate from any adverse movements [see also 5 Worst ETF Strategies Of The Last 5 Years].

Over time, these target retirement date ETFs will evolve, shifting allocations to asset classes with risk profiles that are more inline with investors’ objectives. So in the next 25 years, one would expect the 2040 fund to gradually shift away from equities towards bonds, eventually forming a portfolio that is very similar to how the 2015 fund looks today. 

To achieve the different portfolio compositions, target retirement date ETFs actually invests in other exchange-traded products, essentially becoming a sort of “fund of funds.” iShares, for example, invests in its own ETFs, including  the S&P 500 Index Fund (IVV), Barclays Aggregate Bond Fund (AGG), MSCI EAFE Index Fund (EFA) and S&P Midcap 400 Index Fund (IJH) [see our Retirement ETFdb Portfolios].

Benefits And Disadvantages

The adaptability of these funds is perhaps one of the most obvious reasons investors choose to invest in target retirement date ETFs. Once one of these ETFs are purchased, investors can sit back and let the security shift allocations to the most appropriate asset classes which best reflect the holder’s risk profile. Furthermore, investors won’t have to sift through the over 1,400 ETPs to build their long-term portfolios. Instead, a single equity ticker provides fine-tuned exposure to a diversified basket of securities. But because these ETFs are funds that hold other ETFs, holders will have to burden a double layer of  fees. While these expenses might be relatively low, they can add up over a long period of time. Potential investors should also take a close look under the hood of these ETFs since they only follow general rules to determine allocations, meaning that the resulting portfolio may not be exactly in line with your investment objective.

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Disclosure: No positions at time of writing.