In investors’ search for safe and profitable investments, target return funds emerge as a financial vehicle designed for those investors who are more inclined to predictable returns and protection of invested capital.
Although it is not a novel instrument, in the current financial context it is gaining more and more importance, driven by the fact that it is an attractive option for those seeking to invest with a clear vision, minimizing exposure to possible volatility scenarios. If you are going to create your investment portfolio, you should take this financial product into account.
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ToggleWhat is a target return fund?
A target return fund is, in essence, a specific investment option within the category of fixed income funds, designed to offer investors a defined return or target return over a given period.
To understand how it works, let’s consider, as an example, the case of Raul, who plans to buy his first home in three years. He decides to invest in a target return fund that promises him an annual return of 4% and, in addition, guarantees capital protection. Throughout this time, the fund adjusts its portfolio, diversifying into stocks and bonds to meet his goal.
During these three years, Raul enjoys the stability offered by the fund and its focus on capital preservation, which allows him to accumulate a considerable sum for the purchase of his home.
Unlike other funds, its role in the financial market is to provide greater predictability in performance, which is attractive to investors seeking clarity in their financial objectives.
Characteristics of target return funds
- Predefined target return: Individuals investing in target return funds enjoy greater predictability regarding the cumulative return the fund will generate until its maturity or liquidation date. This is possible because the funds clearly state a target return, as opposed to funds with a specific, non-guaranteed target return, allowing investors to anticipate the growth of their investment over time.
- Capital protection to limit losses in adverse market situations: A distinct feature of target return funds is that they offer capital protection, which helps investors limit their losses in scenarios that may threaten expected investment performance.
Capital protection is a widely used investment strategy in the financial arena, as it seeks to protect the value of money and avoid losses for those who invest. Especially nowadays, when financial markets are inherently volatile and subject to fluctuations, having an instrument to back up capital is crucial for many investors.
- Risk-adjusted portfolio composition: The choice of assets in the portfolio is made taking into account the level of risk the fund is willing to accept. This helps the fund adjust to market variations, while remaining focused on achieving its target return.
- Flexibility in management: The managers of these funds have the freedom to decide how to invest investors’ money. Most importantly, this flexibility allows them to adjust investment strategies according to market conditions and investor needs.
For example, if there are changes in the economy that affect the performance of certain assets, managers can rebalance the portfolio quickly, moving money into safer or more profitable investments. This adaptability is critical to maximizing returns and protecting capital.
Advantages and disadvantages of investing in a target return fund
Advantages of target return funds
The main advantage of target return funds lies in their ability to offer a predictable return, aligned with the investor’s financial objectives. From the outset, it is possible to know with a high degree of certainty the expected return, which facilitates both short and long-term financial planning.
In addition, the stability provided by these funds contributes to investor confidence, as it guarantees the protection of the investor’s capital and establishes a clear return objective.
In general, target return funds are presented on an annualized basis, which means that they show the expected return in terms of annual percentage. Such a presentation is useful for investors, as it allows them to better understand how the fund’s performance aligns with their financial objectives and facilitates comparison with other investment alternatives.
Disadvantages of target return funds
One of the main disadvantages of target return funds is that, in rising markets, their focus on capital protection and achieving a predetermined return can limit the potential for higher returns. By prioritizing capital preservation, these funds miss the opportunity to take advantage of the higher returns offered by rising markets.
The purpose of these funds is to lock in a specific return, such as 3% or 5%. However, if the market rises by more than, say, 10%, the fund will not be able to fully benefit from that rise, as its strategy is designed exclusively to meet the predefined target.
On the other hand, these funds include some risks and defaults on the bonds that comprise them. The strength of the bonds is a key factor influencing this type of risk, since if the bonds fail, the stability of the fund is compromised.
Another disadvantage is liquidity risk. If it is decided to withdraw the capital before the fund’s maturity date, the return obtained may be considerably lower than expected, and could even generate a capital loss.
Choose target return funds with the help of inbestMe
For investors interested in target return funds, inbestMe offers options that facilitate investment in these products. Its personalized and diversified approach allows investors to manage their capital more efficiently, adapting to different risk profiles and return objectives.
As a robo-advisor, inbestMe uses an automated platform that selects funds through its Target Portfolio, composed of ETFs and Target Return Funds. This financial instrument helps diversify short-term investment by integrating bonds of the best companies that can forecast a specific return at maturity.
It should be noted that although the expected return of your EUR Target Portfolio is not guaranteed, it is calculated based on the return of the bonds that make up the portfolio at maturity. Compared to a deposit or treasury bills, inbestMe’s Target Portfolios provide superior diversification and more effective tax advantages, making them an excellent choice for choosing target return funds.