Nothing is Simpler
During our lectures and workshops, we often explain that while financial planning can sometimes be difficult, investing itself is typically straightforward. Choosing investments is much easier now that there are “Target Retirement” type investment choices readily available. These investments have various other names, such as “Target Date” or “Lifecycle” funds, but the general idea is the same. You can choose ONE investment, in all of your accounts, and never have to do anything different, ever. Almost sounds too good to be true, right?
What’s the Catch?
There is no catch or gimmick. You probably all have a Target Date mutual fund in your 401k or 403b. These are simply “all-in-one” funds which contain a mix of 1) US stocks 2) International stocks and 3) Bonds. These three components represent the bulk of any healthy portfolio. Target Date funds simply combine those three asset classes into one package. Just choose a Target Date fund, and you’ll own everything you need, and everything you’ll ever need.
How do they Work?
Target Date funds are available in a series, with a date associated with each fund. For example, Vanguard’s “brand” of funds are called Target Retirement funds. There is a Target Retirement 2060, Target Retirement 2055, Target Retirement 2050, etc. The date represents the approximate year one is likely to retire or stop working. For example, a 30 year old today might assume they’ll retire around age 60. Which would be 2051, and thus a Target Retirement 2050 or 2055 would both be fine choices. You typically aren’t stuck with any particular date if you change your mind later, especially within retirement accounts (i.e. 401k, 403b, IRA, etc).
It is a generally accepted principle that younger investors should have a stock-heavy portfolio (with a smaller amount in bonds), but that the ratio of stocks to bonds should decrease as one approaches and enters retirement. Target Dates funds have a “glide path” such that they gradually adjust this ratio for you. You keep the same Target Date fund through the years, and your stock to bond ratio will automatically be adjusted for you. It’s like having a free investment manager!
Glide Path? Sounds Complicated.
Nope, not complicated. And the fund will do all the work for you. Below is a schematic taken from a very helpful page at Vanguard. In fact, that page is so helpful you probably don’t need to read THIS one. Sigh. Anyway….
The graph shows that as one ages the amount of “stocks” (US Stocks and International Stocks) decrease, while “bonds” (the blues and greens, lol) increase. During the “accumulation phase” of your career (that is, when you are actually saving and growing your retirement savings) you simply continue to buy additional shares of the same Target Retirement fund. Later when you actually need to use your savings to live on, you just sell portions of the same fund as needed.
Each mutual fund “brand” (e.g. Charles Schwab, Fidelity, etc) has a slightly different glide path and a different composition each for stocks and bonds. But the general principles are the same and there is not necessarily one “fund family” that is better than another, except for…COST.
Cost? Aha, I Knew There Was a Catch!
No, not really. Every investment has some cost to you. For mutual funds (and a similar type of fund/investment called an “ETF”) the cost is represented by the “Expense Ratio” which is expressed as an annual percentage of your total investment. You want to keep your fees as low as possible, the lower the fee, the more money you make or keep.
Mutual Fund Fees, in the “Wild”
The image above shows the list of investment options from the 403b of a very large hospital system. The Target Date funds are on the right, with an associated fee of 0.09%. Trust us, that’s considered very low (i.e. very awesome) as is typical of Vanguard funds. We consider anything under 0.1% to be “free”, essentially. It’s a trivial investment expense. But compare this to other options in the 403b on the left. You can see there are other very low fee choices (arrows). But there are also “traps” (circles) designed to ensnare the uneducated. These are exceedingly high fee investment options that no prudent investor need select. In one manner of speaking, 403b participants who choose these high-fee traps subsidize the employees who choose the low-fee options. Don’t get trapped! We mention mutual fund expense ratios to warn you that despite the awesomeness of the Target Retirement fund concept, there are some brands of Target Retirement funds which have very high fees and which are sometimes high enough to make them a poor choice for those who have significant investments.
Highly Recommended Additional Reading
Christine Benz at Morningstar (an investment related website/company) wrote a wonderful article discussing the benefits of Target Date funds. Now that you understand the basics of Target Date funds, you’ll appreciate her additional insights and education.
Not sure if a Target Date fund is right for you? Well in that case, IT IS.
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