If you are a young professional just beginning to save for retirement, you are probably wondering about the best way to do it.\u00a0 If you have not yet come across target date funds, you will eventually.\u00a0 They are one of the most popular retirement investment vehicles.\u00a0 Morningstar reported in May of 2020 that target date strategies held $2.3 trillion at the end of 2019.<\/p>\n
Despite their widespread use, target date funds (TDFs) are not without their pitfalls.\u00a0 We will explore TDFs and consider both their advantages and their disadvantages.\u00a0 While you may find them in your employer\u2019s retirement plan, they may not be right for you.<\/p>\n
A target date fund is a fund offered by an investment company (i.e. mutual fund) that has an asset allocation (i.e. mix of asset classes like stocks and bonds) that becomes increasingly conservative over time.\u00a0 They are also called \u201clife-cycle\u201d or \u201cage-based\u201d funds.<\/p>\n
Think of the fund on a glide path.\u00a0 The start of the path is today and the end of the path is your retirement age.\u00a0 So, if you were born in 1990 and you plan to retire at age 60, then your target date is 2050 and you would invest in a \u201c2050\u201d fund.\u00a0 The longer\/shorter the glide path, the more aggressive\/conservative the fund will be.<\/p>\n
A TDF generally contains other funds.\u00a0 These sub funds represent various asset classes the manager wishes to include in the fund.\u00a0 A TDF may include, for example, funds for US stocks, international stocks, US bonds and international bonds.\u00a0 The mix (i.e. percent) of each of the funds will change as the fund glides toward its target.\u00a0 Specifically, it will contain less stocks (which are aggressive) and more bonds (which are conservative) over the life of the fund.<\/p>\n
What happens when you reach the target date? A \u201cthrough\u201d TDF will have an asset allocation that continues to become increasingly conservative.\u00a0 A \u201cto\u201d TDF will maintain a fixed asset allocation once the target is reached.\u00a0 Sometimes these funds \u201cconvert\u201d to other singular funds when then they reach their terminus.<\/p>\n
TDFs are attractive, because they are professionally managed and they require no decision making by the investor other than selecting the proper fund.\u00a0 They are highly diversified.\u00a0 They are simple to understand.\u00a0 They are automatically rebalanced and re-allocated over time.\u00a0 They are often referred to \u201cset-it-and-forget-it\u201d or \u201cauto-pilot\u201d funds.<\/p>\n
Investors often underperform the market, because they make poor investment<\/a><\/span><\/strong> decisions. They pick the wrong funds.\u00a0 They try to time the market.\u00a0 They change funds.\u00a0 Investing in a TDF makes it impossible to make these mistakes.<\/p>\n If you are investing in your employer\u2019s retirement plan (e.g. 401(k) or 403(b)), you will be limited to the funds in the plan.\u00a0 You would generally (there are exceptions) select the fund that corresponds with your retirement date.<\/p>\n If, however, you are considering investing in a TDF within your IRA or Roth IRA or brokerage account, you will have more options.\u00a0 Vanguard is the largest TDF provider with a market share of 36.5%.\u00a0 Fidelity (19.4%) and T. Rowe Price (13.1%) are also significant players in the TDF arena.<\/p>\n You should consider the strategy, asset allocation and glide path of the funds that might be appropriate for you.\u00a0 If you are considering actively managed TDFs (vs passive funds), you should evaluate the performance of the funds relative to an objective (blended) benchmark.\u00a0 You should also look at the expense ratios of the funds and gravitate to the less expensive TDFs.<\/p>\n <\/p>\n You might be thinking TDFs sound like the perfect retirement savings vehicle.\u00a0 But there are several significant problems with these funds.<\/p>\n The benefits of a TDF come at a price, unless you are discerning. Morningstar reported that the average, asset-weighted expense ratio for target date mutual funds was 0.62% in 2018. However, TDFs are not all alike.<\/p>\n Let\u2019s go look at some 2050 funds. We will consider TDFs from four of the largest players in the market.<\/p>\n Source: Morningstar<\/p>\n A few things jump out at us.\u00a0 The Vanguard fund and the BlackRock fund are much less expensive than the other two funds.\u00a0 Also, the BlackRock fund is much more aggressive than the other three funds.\u00a0 The lesson here is that you really need to lift up the hood on TDFs and understand how they are made and what they cost.\u00a0 In general, TDFs are more expensive (often much more so) than basic, low cost mutual funds and exchange traded funds.<\/p>\n Another problem with the whole concept of TDFs is that they are a one-size-fits-all vehicle.\u00a0 So, in theory every person planning to retire in 2050 would use the same TDF.\u00a0 But we know that investors are not all alike.\u00a0 We can describe investors by their risk temperament, their assets, their income sources, their spending needs, their investment horizon, etc.\u00a0 The 2050 funds above might be very appropriate for a young professional with a high tolerance for risk and a need to accumulate a large nest egg over a long working career.\u00a0 However, they would be inappropriate for someone who is risk averse, who has or will inherit significant assets and, therefore, has no economic necessity to be aggressive with her investments.\u00a0 They might also be a poor fit for someone who reaches 2050 and still has a need to grow his investments while in retirement.<\/p>\n Yet another challenge with TDFs is that they do not combine well with other funds that have a more static asset allocation.\u00a0\u00a0 The asset allocation in the TDF will be constantly along the glide path to the target date.\u00a0 So, if you are trying to maintain an overall asset allocation across several accounts, you will have to rebalance all of the other accounts with reference to the TDF.<\/p>\n As we have seen that all depends on your circumstances.\u00a0 If the asset allocation within a fund you are considering meets your needs and you are willing to pay a premium for an \u201call-in-one\u201d fund, then a TDF may make sense for you.\u00a0 However, if you are willing to build a more complex portfolio (or hire someone<\/strong><\/a><\/span> to do it for you) that is customized to your situation, then you should probably avoid TDFs.<\/p>\n","protected":false},"excerpt":{"rendered":" If you are a young professional just beginning to save for retirement, you are probably wondering about the best way to do it.\u00a0 If you have not yet come across target date funds, you will eventually.\u00a0 They are one of the most popular retirement investment vehicles.\u00a0 Morningstar reported in May of 2020 that target date […]<\/p>\n","protected":false},"author":2,"featured_media":4874,"comment_status":"open","ping_status":"open","sticky":false,"template":"","format":"standard","meta":{"_et_pb_use_builder":"","_et_pb_old_content":"","_et_gb_content_width":"","_mi_skip_tracking":false,"footnotes":""},"categories":[6,7,11],"tags":[66,119,140,162],"aioseo_notices":[],"_links":{"self":[{"href":"https:\/\/springwaterwealth.com\/wp-json\/wp\/v2\/posts\/4872"}],"collection":[{"href":"https:\/\/springwaterwealth.com\/wp-json\/wp\/v2\/posts"}],"about":[{"href":"https:\/\/springwaterwealth.com\/wp-json\/wp\/v2\/types\/post"}],"author":[{"embeddable":true,"href":"https:\/\/springwaterwealth.com\/wp-json\/wp\/v2\/users\/2"}],"replies":[{"embeddable":true,"href":"https:\/\/springwaterwealth.com\/wp-json\/wp\/v2\/comments?post=4872"}],"version-history":[{"count":0,"href":"https:\/\/springwaterwealth.com\/wp-json\/wp\/v2\/posts\/4872\/revisions"}],"wp:featuredmedia":[{"embeddable":true,"href":"https:\/\/springwaterwealth.com\/wp-json\/wp\/v2\/media\/4874"}],"wp:attachment":[{"href":"https:\/\/springwaterwealth.com\/wp-json\/wp\/v2\/media?parent=4872"}],"wp:term":[{"taxonomy":"category","embeddable":true,"href":"https:\/\/springwaterwealth.com\/wp-json\/wp\/v2\/categories?post=4872"},{"taxonomy":"post_tag","embeddable":true,"href":"https:\/\/springwaterwealth.com\/wp-json\/wp\/v2\/tags?post=4872"}],"curies":[{"name":"wp","href":"https:\/\/api.w.org\/{rel}","templated":true}]}}How to select a Target Date Fund<\/strong><\/h2>\n
Want to learn more about financial planning? Contact our team at Springwater Wealth today to learn how we can help you develop a plan for your financial future.<\/a><\/strong>\u00a0<\/span><\/h2>\n
Pitfalls of Target Date Funds<\/strong><\/h2>\n
\n\n
\n Fund<\/strong><\/td>\n Gross Expense Ratio<\/strong><\/td>\n Percent in Bonds<\/strong><\/td>\n<\/tr>\n \n Vanguard Target Retirement 2050 Fund<\/td>\n 0.15%<\/td>\n 8.53%<\/td>\n<\/tr>\n \n Fidelity Freedom 2050 Fund<\/td>\n 0.75%<\/td>\n 5.87%<\/td>\n<\/tr>\n \n T. Rowe Price Retirement 2050 Fund<\/td>\n 0.71%<\/td>\n 5.58%<\/td>\n<\/tr>\n \n BlackRock LifePath Index 2050 Fund<\/td>\n 0.14%<\/td>\n 1.43%<\/td>\n<\/tr>\n<\/tbody>\n<\/table>\n Should you use a Target Date Fund?<\/strong><\/h2>\n