Target Date Funds
Is Neglecting Your Investments a Good Thing?
You’ve probably seen them available within your 401K. These days almost every big financial institution has their own version of the Target Date Fund.
They are simple to implement. If you are planning to retire in say, the year 2028, then you invest in a Target Date Fund labeled 2030 (or 2025).
These funds are designed to start you off with a high allocation of stock which is maintained for your early working years. As you get closer to retirement, stock is gradually replaced with more bonds (and cash equivalents). Once you’re ready to retire you have a more bond-heavy portfolio, focused on both income and growth.
In the chart above, those retiring right now would be in a 2020 fund. Those who’ve already retired would be in a fund to the right of 2020, and those still working are in a fund to the left of 2020.
Target Date Funds are available in five-year increments (2020, 2025, 2030…). As these funds haven’t been around for long, the earliest is 2005. The latest, just created, are for the nineteen-year-olds retiring in 2065.
The strategies of these funds should be consistent over time. If you wish to know what will be happening in your 2030 portfolio ten years from now, then look at the 2020 Fund. Twenty years from now your 2030 portfolio should resemble the current portfolio of the 2010 Fund.
The chart above not only reflects the current allocation of each of Target Date Fund but the future expectation as each fund ages forward.
Here are some example Target Date Funds from my three favorite financial institutions. (No affiliation here, I just hold accounts at each.)
Example Target Date Funds from Fidelity, Charles Schwab, and Vanguard
Both Fidelity and Schwab provide two kinds of target date funds for each 5-year period: a regular fund (chart above) and an index fund. Due to low expense ratios, the index funds have been listed above. Vanguard target date funds are composed of their other own index funds.
For all three fund companies, expenses are very low, with Schwab beating out everyone at a ridiculous 0.08% expense ratio.
(There’s a reason these three are my favorites…)
All three are very similar in their respective allocations of stocks vs bonds for a given target year.
What about your individual risk tolerance?
One criticism of Target Date Funds is that they don’t consider individual risk tolerance. Perhaps you are an aggressive investor and at age 55, you’d still like to be >90% in stock.
You can game the system a bit. There is no law that requires you to buy the Fund that corresponds to your retirement date. If you are 55 and retiring at age 65, instead of investing in the 2030 Fund, go for the 2040 Fund instead.
If you are conservative investor, buy a fund with an earlier date. However, it will be important that you have your financial planner calculate if you can still achieve your retirement goals with a lower expected return.
Will you be on track for retirement?
Super-savers putting aside a large chunk of their paycheck can afford a higher percentage of bonds and still make their retirement target. They may wish a bond allocation higher than that of a Target Date Fund.
Those of us “behind” in saving may need to be aggressive and push the envelope with a high stock allocation, even 5–10 years out from retirement.
All of us are different and need a different allocation of stocks and bonds, even those of us the same age, planning to retire the same year.
Like above, you can game the system by investing in a different Target date.
But you may be better off determining your own allocation, especially if you are at one of these extremes.
Only if your investment “style” matches that of a Target Date Fund should you invest.
What about after retirement?
Conventional wisdom-which these Target Date Funds are based on-recommends becoming more conservative the closer you get to retirement.
You don’t want to hit a big bad Bear market immediately before, or early in your retirement. This is referred to as Sequence of Return risk. Those who suffer market issues early in retirement may never catch up.
But what about later in retirement? More recent data by Pfau WD, et. al. suggests that entering retirement with a bond-heavy conservative portfolio, but gradually increasing your stock allocation over time improves your success rate. (Success rate is your odds that you won’t run out of money.)
During your retirement, you may need an additional three-plus decades to stretch your savings. You’ll need the growth stocks provide.
In their study, a modeled portfolio that started retirement at 30% stock and finished at 60 percent, did better than a portfolio that stayed at 60% equities throughout. Both of those options did better than a portfolio that started at 60% stock and ended at 30%.
The authors included other percentage allocations in their study and generally found good results with a portfolio that started retirement with 20–40% stock and ended with 60–80% stock.
If you wish to move from 30% to 60% equity exposure over thirty or so years, simply add 1–2% stock every time you rebalance annually. Easy to remember.
- If you start with a 30/70 allocation of 30% stocks and 70% bonds/cash, next year rebalance to 31/69. The following year, 32/68. Then 33/67. And so on.
They may exist, but I’ve yet to come across a Target Date Fund that implements a rising equity glide strategy after retirement. Instead, the Target Date Funds above continue to get more and more bond heavy!
As you get near retirement you may need to trade in your Target Date Fund for a traditional 30/70 portfolio. Then manually apply the rising equity glide after retirement.
If you are already retired and this strategy seems a bit scary, keep in mind that a relatively high percentage of bonds are held during the decade prior to, and following retirement. This in part balances out the higher equity exposure later. If you look at equity exposure overall it may be similar to a typical 60/40 portfolio.
Investor fear and neglect
Are Target Date Funds perfect? Far from it. But their biggest advantage may be to encourage investing for those hesitant to invest.
For most of us, pensions are gone. Social security will only cover a portion of our needed income. Whether we understand investing or not, we need to start investing for our retirement. And we need to start early — best case, as teenagers.
There is an understandable fear of the stock market. We’ve all heard horror stories. (Some of us still remember 2008…)
Fear of making the “wrong” investment decision and suffering significant consequences later when it’s too late.
Investing can be intimidating, and most of us don’t have the time or inclination to become experts.
You may not even have the time to follow your own investments. You are busy with other priorities. Including working to earn that money to invest in the first place.
Target Date Funds offer an “easy” choice. Just put your money there and forget about it. No need to worry about the “right” allocation, no need to worry about adjusting that allocation.
For many amateur investors, this could be a benefit. Many of us (including yours truly) have messed up their returns by constantly changing strategies and allocations.
Moving money from a struggling fund, allocation, or strategy to one that is currently doing well sometimes works. But most of the time you’re simply selling low and buying high. Only to see the new thing start to struggle. Over and over.
Strategy tweaks and changes are important but should be kept to a minimum.
Target Date Funds don’t require your intervention, so you are less likely to provide it. Simply set it and forget it. And know that it will be there when you finally need it.
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This information has been provided for educational purposes only and should not be considered financial advice. Any opinions expressed are my own and may not be appropriate in all cases. All efforts have been made to provide accurate information; however, mistakes happen, and laws change; information may not be accurate at the time you read this. Links are included for reference but should not be considered an implied endorsement of these organizations or their products. Please seek out a licensed professional for current advice specific to your situation.