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No matter what your investment goal, managing risk as you get closer to the end of your investment time horizon is crucial.
Whether you’re investing to build up a house deposit, pay for school/university, or for retirement, you need to dial in your risk levels as you get closer to the date you need your money. Otherwise, you run the risk of seeing the value of your portfolio take a hit right before you plan to cash out.
One type of product that can potentially help investors to navigate the complexities of this area of risk management is “target-date” or “target-year” funds. These are designed to automatically adjust your portfolio risk levels as you get closer to a specific date. Here’s a look at how they work, and a brief overview of eToro’s new target-year Smart Portfolio offering.
The link between time, risk tolerance, and asset allocation
Investment risk tolerance refers to the amount of portfolio volatility an investor is willing and able to accept as they work towards their financial objectives. It’s different for everyone and there are many variables that can impact it. However, when thinking about your risk tolerance, it makes sense to consider how much time you have until you need access to your capital. If you have a long-term investment time horizon, you will have time to recover from potential losses, potentially allowing for a higher risk tolerance and a more aggressive asset allocation (more exposure to high-growth assets such as stocks). On the other hand, if you are nearing the time when you are going to need access to your money, you may not have time to recover from potential losses, so it makes sense to prioritise preservation of capital and adopt a more conservative risk tolerance and asset allocation (more focus on safer investments such as bonds and cash).
Managing risk with target-year funds
Now, adjusting your portfolio’s risk level as you move through your investment journey – and get closer to the end of your time horizon – can be challenging. This is where target-year funds come in. Designed to help investors to effortlessly manage risk when working towards a particular goal, these funds automatically adjust their asset allocation over time. Typically, they follow a predetermined "glide path" – an automatic schedule that gradually shifts the fund's asset allocation from more aggressive (a high allocation to stocks) to more conservative (more bonds and cash) as the target date approaches.
These funds are easy to use. All you need to do is choose a fund that has a target date that matches the year you expect to need your money. For example, if your goal is to buy a house in 2030 and you are investing your money to save up a house deposit, you would choose a 2030 target-year fund. This would reduce its allocation to risky assets as 2030 approaches so that there is a low chance of a disappointing financial result when you need your money.
A range of benefits
Note that target-date funds offer investors several major benefits beyond ongoing risk management. One is that they take the hassle out of portfolio construction. Building and maintaining a diversified investment portfolio can be complex. Often, it can be hard to decide what percentage of each asset class to hold, especially across domestic and international markets, and different company sizes. With target-year funds, investors get access to fully diversified portfolios built by professionals.
Another benefit is that they allow investors to take a “set-and-forget” approach. With these portfolios, no ongoing tinkering is required. So, they can be a great option for those who want to take a hands-off passive approach to investing.
One other benefit worth highlighting is that they can be used for a range of investment goals. Whether you’re investing for a shorter-term goal, such as a wedding or a side business launch, or a longer-term goal, like retirement, they can be very effective investment vehicles.
To help investors manage risk and achieve their financial goals, eToro recently launched a range of target-year Smart Portfolios in conjunction with investment manager Franklin Templeton.
These portfolios invest in a mix of global ETFs for broad market exposure and diversification and follow predetermined asset allocation glide paths to lower risk over time. Funds available on the platform include:
Target 2028 – Stability-focused, but offering potential for some growth, this portfolio starts out with a 40% equity weighting and a 60% fixed-income weighting and will gradually shift to 90% fixed income over time.
Target 2033 – More growth-focused, this portfolio starts with an 80% weighting to stocks and will gradually shift towards lower-risk fixed-income assets.
Target 2035 – A longer-term strategy, this portfolio is growth-oriented and more aggressive, beginning with a 90% higher-risk equity allocation to maximise early growth potential.
With these Smart Portfolios, there is no lock-up period, meaning that you are free to add or withdraw funds at any time. You can find more information about these portfolios in the Smart Portfolio section of the eToro platform.
