[This post on target date funds is intended to be educational only does not constitute investment advice. If you haven’t yet, please take a moment to read the website disclosures here.]
An initial distaste for target date funds
I used to be jaded. I hated target-date funds. I viewed them as useless investments that ran contrary to my beliefs – partly due to my Boglehead tendencies and partly due to my advisory background.
You see, bogleheadism is rooted in index investing through tailored exposure to stock and bond funds. Pair this mentality with advisor training, where you learn never to place clients in generic portfolios, and you become quick to dismiss target-date funds.
After all, advisors who use generic portfolios can lose their license and be fined for a breach of duty.
Thus to be comfortable with risk and reward through your effort or someone else’s was essential, or so I thought. However, my beliefs changed while working as an advisor exclusively serving those with employer-sponsored retirement accounts. Slowly, I opened my eyes, developing a love for target-date funds.
But how did this happen?
My reckoning
When you work with employer-sponsored retirement plans, you quickly discover that most account holders are accidental investors.
Some individuals participate due to automatic enrollments, others because of a company match. However, the majority participate in their 401(k) because their employer or friend told them to. Thus, they choose their investments and contribution amount, then return to daily life.
From my experience, accidental investors make up the majority of 401(k) participants. That is not to dismiss steadfast investors who deliberately sign up, but most individuals don’t understand investing and the power it holds.
Instead, it is routine and just another part of getting set up at a job. Workers sign up for their health insurance, elect tax withholdings, and check a box to participate in the company 401(k) plan.
However, this mundane process is essential because most people would otherwise not invest. Thus, in my opinion, the rise of the accidental investor is synonymous with the emergence of the 401(k). Notably, accidental isn’t a derogatory term. Instead, it means investing isn’t the primary focus. These investors sign up for various reasons when starting a job, and for many, it is just another task.
Herein lies the beauty of target-date funds, though: For those who do not have the time or desire to learn about investing and do not want to pay someone to manage it, target-date funds are a blessing.
The realization
Gone are the days of pensions; retirement is now the responsibility of the individual, no one else.
For better or worse, this has become the American way, as social security is not enough.
Often I talked to investors who had set up their 401k twenty years ago or more. After initially ticking the boxes, they never revisited it. Then as retirement approached, the desire for help arose.
As an advisor, this placed me in a unique position to learn about the experiences of many. I talked to thousands of individuals, and I frequently ran into two main camps of investors: 1) Those who chose investments and then let go of the reins and 2) those who went with the default investment.
[Default investments generally are target-date funds]
More often than not, those without target-date funds and who hadn’t self-managed their investments became seasick. After all, they had just recently started paying attention to their assets which only had grown riskier with time and no rebalancing.
However, those with target-date funds were generally much more comfortable with their portfolio fluctuations.
Why? Because target-date funds had helped these investors grow their money and de-risk their portfolios as they aged. How? Automatic rebalancing and a gradual shifting towards less risk over time.
This is the power of target-date funds.
[While other influences were at play, this trend became pronounced nonetheless.]
Target-date funds are great
Hence it became apparent meeting after meeting that target-date funds were a force for good. And importantly, they remain to be.
My beliefs have radically changed since my initial reluctance to accept target-date funds. That is not to say everyone needs a target date fund – they don’t – but they benefit many and have a broad appeal. If it makes the difference between too much risk or too little, how could one argue against them?
Parting thoughts
So, next time you hear someone downplaying target-date funds, don’t buy into it. These funds provide automatic investing and rebalancing for countless Americans daily, and that is a great thing.
While some people are better suited to manage their investments, others have little interest. There is no correct answer, but sometimes the cookie-cutter approach of target-date funds is warranted. Because everyone’s situation is different, no two individuals will ever be homogenous. Thus, whether it be index investing, using target-date funds, or professional management, there are countless paths to financial freedom. Choose what works best for you and carry on!
How to choose a target-date fund?
The answer is simple if you have a 401(k) or 403(b) plan! Choose the target date fund that is closest to your retirement year. If you are retiring in 2034 and your plan offers a 2030 and 2035 fund, 2035 is the nearest choice. If you plan to retire in 2031, 2030 is the closest choice.
However, if you have an IRA or brokerage account, you will have many mutual fund providers to choose from instead of just one. You need to ask yourself if you want an active or index target-date fund in this situation and if you have a fund provider preference. If you settle on an index fund but are unsure which provider to choose, this post can help your decision-making process. However, still follow the closest year rule of thumb from above!
Let me know in the comments below
Are you a fan of target-date funds, or how do you invest? I would love to hear about your experience with them in the comments below. As always, have a great day!
Mile High Finance Guy
finance demystified, one mountain at a time
Stumbled upon your site and love the layout/graphics, not to mention the content!
Target Date funds are a great option for a large percentage of the working class–not only to invest in, but to easily understand what they’re investing in. I prefer the all-stock VTSAX approach rather than include bonds at this stage of my life, but I wouldn’t fault anyone going with a Target Date.
Thanks, Impersonal Finances! I heavily favor an all-stock portfolio, too. The VTSAX approach is time-tested and is a great way to invest. I deploy a five fund portfolio with US Large Cap, US Small Cap Value, Total International, REITs, & Total Bond Market.
I generally try to keep bonds between 3-5% of my portfolio, which is my sweet spot for risk-adjusted returns after backtesting numerous portfolios.
I loved your post on why You’re Probably Getting Screwed by Edward Jones Fees. I regularly ran into clients when I was working with 401ks that had EJ nightmare stories regarding fees – there is a reason they can afford to be on every street corner!
It has been both refreshing and alarming to receive some of the feedback on that particular post. It’s nice that I wasn’t alone in my experience with them, but also, it’s HORRIBLE that I wasn’t alone in my experience. The wound is still fresh and I broke up with them nearly a decade ago.