Hugh F. Wynn
Target-Date Funds Let You "Set It and Forget It"
Being diehard fan of mutual funds, especially index funds, I’ve developed a fondness for an increasingly popular group of funds called Target-Date or Target Retirement funds. In my mind, they represent as big an innovation for small and new investors as the popular index funds on which they are based. They are a great example of the adage, “Set it and forget it,”as the late pitchman and creator of the television infomercial, Ron Popeil, would say. NOTE: Since I’m not a credentialed financial advisor, the answers (observations) I give are strictly my opinion.
Why Target-Date Funds?
A target date fund is an investment fund that automatically changes your investments from high-risk, high-reward to low-risk, low-reward holdings as you near retirement.
Asset selection, allocation, and reallocation can be very stressful to some investors. Target-Date funds perform those functions both at the point of purchase and through retirement…with historically positive outcomes for their owners. These all-in-one funds offer a mix of domestic and international stock and bond funds, often with inflation-protected securities thrown in early on, to round out the portfolio – a highly diversified package of assets with that important reallocation feature.
Increasingly accessible in IRA, 401(k), and 403(b) accounts or in personal non-retirement accounts, investors are able to purchase Target-Date funds and then forget about them if they are so inclined. Studies show that they are especially popular with investors who care to devote very little time to their investment portfolios…or who have minimal interest in but recognize the importance of investing…or who are attracted to an investment portfolio that reallocates its domestic and international stock and bond components automatically as one approaches retirement.
A Fund that Ages Well
Money invested in a Targe-Date fund is invested into a mix of securities. Initially, riskier assets, such as stocks, make up the majority of the fund's portfolio. As the Target-Date fund "ages," the mix of securities slowly shifts with the portfolio increasingly allocated to more conservative investments.
Take, for example, Vanguard’s Target Retirement 2050 (VFIFX). If a 30-year-old millennial plans to retire or stop working in 30 years (2051), the Target Retirement 2050 would be a good fund to consider. As of mid-2021, the fund's allocation mix is:
Total Stock Market Index Fund - 54.2%
Vanguard Total International Stock Index Fund Investor Shares - 36.2%
Vanguard Total Bond Market II Index Fund Investor Shares - 6.5%
Vanguard Total International Bond Index Fund Investor Shares - 3%
Vanguard Total International Bond II Index Fund - 0.10%
Note that the vast majority of the fund is invested in stocks, and better yet (in my opinion), in stock market index funds. This reflects the fact that a younger investor has more time in the market, so can logically withstand a riskier (but perhaps more lucrative) investment mix. This mix will slowly change as the years inch toward 2050.
A common component of long-term investing involves rebalancing the stock-bond ratio in a portfolio due both to market forces and the aging process. Young investors’ portfolios should be more heavily weighted in stocks (or stock funds) than bonds. Accordingly, that ratio of stocks to bonds should decrease as investors age…particularly as they enter their retirement years.
Target-Date funds gradually make this adjustment without input from the investor. In short, during what is commonly called the “accumulation phase” of one’s career (the saving and growing phase), the investor simply continues to buy additional shares of the same Target-Date fund. Later, in retirement or when the investor stops working and needs money for cost of living purposes, portions of the same fund are sold as required.
By the way, an investor isn’t locked into any particular “date” should a change of heart or life-changing event occur down the road…an especially important feature in retirement accounts.
Watch Your Fund Fees
With most companies, the general principles of Target Retirement fund investing are similar. But that’s not to say their costs are similar. Some firms simply charge more – enough to make a significant difference over the course of an investor’s career. No investment is free.
Mutual funds charge what’s called an “expense ratio” – expressed as an annual percentage of one’s total investment. In 2020, the average asset-weighted fee for Target-Date funds was a tiny bit over 0.50%. By the way, reflected in that fee is the all-important reallocation assistance thrown in as part of the deal.
Not surprisingly, the lower this fee, the more money you make…or as Vanguard’s Jack Bogle would remind you,“The more of your money you get to keep.” Vanguard is very good at allowing its owners…you…to keep more of your money than most investment firms. There are no billionaire owners chewing away at Vanguard’s bottom line. So, be a prudent investor. Check out those annual expense ratios.
By and large, company retirement plan participants aren’t terribly active investors. Vanguard's report, "How America Saves" studied 5 million participants in the company’s defined-contribution plans and found that in 2019, only 7% did any trading at all. Amazing. In short, they made their choices among the funds offered, and then tended to do nothing…including seeking available advice.
Target-Date funds are a natural choice for investors who tend to buy age-appropriate asset mixes; who gradually become more conservative as they age; who should rebalance their portfolios on an ongoing basis – but tend not to because it can be difficult; and who could use some advice along the way, but often choose not to seek it even at a very reasonable cost. By offering minimal oversight and basic asset-allocation advice, Target-Date funds could…and increasingly do…provide retirement-seeking investors with a vital product and service.