I haven’t looked at any stats recently, but last I checked, target funds are growing in popularity.
The reason is because they make people feel safer. They present a simple, little-knowledge-required way to do your investing.
Thus, they target folks who know little about investing, but want to be saving for retirement. Furthermore, they are ideal for people who don’t want to have anything (hands on) to do with investing as they consider it a waste of time.
I’m all for detaching yourself from investments in some ways and spending your time elsewhere. However, you need to be sure that you’re making a wise choice before you detach yourself from what is happening with your investments.
I’m a hands on guy. Typically, I don’t want to pay others to do what I can do for myself. That’s why I’d rather change my own oil instead of paying a mechanic to do it. That’s why I’d rather book my own flights than pay a travel agent to do it. It’s part of my personal desire to control whatever I can.
My wife, on the other hand (in terms of finances), is an outsource and minimize sort of person. She thinks, why spend hours doing what someone else could do (and even enjoy)?
As such, she’s an ideal candidate for a single target retirement fund or an investment organization like Betterment.
Still, you must remember that there is a trade off when you don’t fully understand what is happening with your investments. Even if you want to get a single target retirement fund, I think you need a minimal knowledge of investing. I suggest you review the basics on how to start investing.
What is a Single Target Retirement Fund?
Target retirement funds are easy to identify because they typically have a date in the name.
For example, Vanguard Target Retirement 2015 fund is suggested for people who plan to retire in 2015. The Fidelity Freedom 2015 would be the Fidelity version of a 2015 targeted retirement fund.
The funds are already allocated according to the risk matrix typical for people retiring in those years. The funds are automatically rebalanced, so as you get older, the managers add a larger portion of bonds and other conservative investments.
The idea is that you just keep dumping all your money in the fund, and they’ll do the work to be sure it is positioned well for your 2015 retirement.
But the question remains, are single target retirement funds a good idea?
Advantage of a Single Target Retirement Fund
- Simplicity. Here’s my check. See you next month.
- Diversification. Within that one target fund, it is possible to own thousands of stocks.
- Ideal for those with less money. Your $2,500 can be more quickly diversified than trying to individually buy the different holdings.
- It’s not a bad thing to do. There are a lot dumber things people could do with their money. While it might not give you the best return for your money, it might be worth the trade off of spending your time doing something else.
Disadvantage of a Single Target Retirement Fund
- You outsource asset allocation. Rather than making your own decisions about your asset allocation, you allow the company do to that. We’ve already established that asset allocation is your most important investing decision. This is true only if you buy based on the target date (i.e. 2020). However, if you buy based on the asset allocation (you don’t look at dates but the percentage of holdings), you can avoid this risk.
- There is no uniform method of allocation. Just because something says 2020 doesn’t mean that it’s the same as every other company that has a 2020 in the name.
As an example, Joseph Slife reports (this article is only available to members):
A case in point: some funds with a 2010 target date had about 20% of their holdings in stocks last year; others had more than 50% in stocks. This explains why last year’s performance among 2010 funds ranged from very modest losses of -3.5% all the way to massive losses of -41.3%, according to data [PDF] from Ibbotson Associates, an industry leader in compiling market statistics.
In other words, you cannot simply outsource by matching your retirement year to the name of a targeted retirement fund.
Personally, I don’t use single target retirement funds. However, it is possible that they might be right for you. An alternative would be comparing the cost of Betterment to the fees you’ll pay on a targeted retirement fund. Both Betterment and single target retirement funds target the same audience. Betterment relies only on purchasing index funds.
For more help on the topic of single target retirement funds, you can see:
- Christian PF Forum: Target Retirement Funds
- Sound Mind Investing (Members Only): Missing the Mark: Many “Target” Funds Fail to Protect Those Nearing Retirement
- Get Rich Slowly: How to create your own target date mutual fund