Target Retirement Funds Are Great

This type of investing is intuitive based on your age and time of retirement, and will continue to adjust itself to help you achieve financial stability when you retire.

People are often skeptical of Target Retirement Funds. Presumably something so simple can’t be worth your time. We’re all taught by Wall Street that investing should be hard. That’s why you need to bring in the pros! They’re more than happy to help. It will only cost you a small fee

But the truth is that investing can be quite simple and Target Retirement Funds are a great way to get started.

You can think of Target Retirement Funds as a “meta fund”. In most cases, a typical Target Retirement Fund will contain separate funds each representing a target market such as Total US Equity Market, Total Non-US Equity Market, Total US Bond Market and Total Non-US Bond Market (the “Four Pillars”).

The Target Retirements Funds then select an allocation between those Four Pillars that is appropriate for your age. Over time, as you get older, the Target Retirement Fund will slowly adjust the mix between the Four Pillars. Typically the equity portion will decrease and the bond portion will increase. By offloading risk, you’ll expect less volatility and lower returns as you approach retirement.

Let’s look at the Vanguard Target Retirement Fund 2050. For a lawyer looking to retire in 2050, Vanguard is currently proposing an allocation that works out to about 90% stocks and 10% bonds (of which the equity is split 60/40 between the United States and International stock markets and the bonds are split 70/30 between the United States and International bond markets):

The Target Retirement Funds make it easy. You pick an approximate year that you’d like to retire and the mutual fund company handles the rest. Since they’re available in 5-year increments, you can be pretty granular on when you expect to retire. Getting “close enough” is good enough when guessing your retirement year.

Vanguard’s Target Retirement Fund 2050 comes with a cool pricetag of 0.16%. This means that you’ll pay $1.60 each year per $1,000 in the fund. That’s a a great price.

But astute investors will notice that the Vanguard Target Retirement Funds use the “Investor” class of the Four Pillars rather than the “Admiral” class. That means a Target Retirement Fund is slightly more expensive than it would cost if you assembled the same fund yourself using the “Admiral” class.

The difference between “Investor” and “Admiral” classes of funds are the expense ratios.

The Admiral class costs less but typically comes with a higher initial required investment. For example, the Vanguard Total Stock Market costs 0.16% for the “Investor” class but only 0.05% for the “Admiral” class. You can get started on the “Investor” class for an initial investment of $3,000 but it takes $10,000 to be able to own the “Admiral” class. If you start investing in the “Investor” class, Vanguard will automatically move you over to “Admiral” once you cross the $10,000 threshold.

When it comes to getting started, the difference in these fees is negligible and it shouldn’t prevent you from investing in a Target Retirement Fund. Once your account grows to large amount (e.g. $100,000?) you can re-examine whether it makes sense to switch out of the Target Retirement Fund into your own asset allocation. But keep in mind that you’ll be responsible for adjusting the equity/bond mix over time (if that’s part of your Investment Policy Statement) and your savings could be as low $80/year (assuming you switch from 0.16% fees to roughly 0.08%).

The only other “negative” for Target Retirement Funds that I can think of is that they make it a little more difficult to track your overall asset allocation. Although, if you’re at the point where your investments are sizable enough that you’re starting to think about asset allocation you’re probably at the point where you should switch out of the Target Retirement Funds so that you can have more granular control.

Remember that when you’re getting started, your savings rate is way more important than than your investment return or a minor difference in fees. Focus on piling up as much money as you can and trust that when you have a big portfolio you’ll figure out a way to optimize it. Target Retirement Funds are a great way to get started and a low priority item for “optimizing” when there’s more important things to focus on, such as keeping your taxes low.

Let’s talk about it. Are you invested in any Target Retirement Funds? Why or why not? If you’re a lawyer, join us over at Lawyer Slack to discuss.

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    Eight thoughts on Target Retirement Funds Are Great

    1. Nice recap, BLI. Yes, target funds indeed are great. I highly recommend it for investors who don’t want to put in the time or effort to allocate and rebalance a three or four fund portfolio. You could save a few basis points with a three-fund portfolio over a target date fund, but the benefit is minimal for smaller accounts.

    2. I think this is a fine strategy for tax-advantaged accounts, but I think more nuance is needed for taxable accounts. If you are in a high capital gains tax bracket, and you think that at any time in the future, you will want to manage these funds individually, you are better off without the targeted funds. Dealing with capital gains once you realize that you want to micromanage can be a pain. However, for medical/law students, or medical residents (or first year law associates?) this approach is very reasonable in a taxable account, as it may allow for “tax-gain harvesting” while in a lower tax bracket.

    3. I got out of the target funds recently. While it makes sense to have a fund of funds which will have you asset allocation over time adjust for you, I don’t necessarily want to be held to that asset allocation.

      Right now, (my 401k options are very limited), I’m in a large cap index fund, a small cap index fund, international equity, and market bond index. I’m going to fund my IRA soon and probably buy a dividend index fund.

      Thanks for the post. It’s great to increase my perspective on these types of things.

    4. My 401(k) plan had all high-expense funds in it for the longest time. Recently, they added Vanguard Target Retirement 2055 Fund Investor Shares. The expense ratio is only 0.18, which is just a fraction of what I was paying for their stupid managed funds.

      I ran Personal Capital’s fee analyzer before and after and figured out that this change alone should save me over $50,000 in fees over a ten year span… completely insane!

      I wish they had other target retirement funds in there so I could aim for my actual retirement date, but it’s a start.

      — Jim

    5. I’m not a big fan of these funds. Part of this is culture, I like having control over my investments even if it’s just asset allocation in index funds. Beyond that it’s also because I don’t not feel your length to retirement should be the only factor in your allocation. Some people have more or less risk tolerance then others, no their allocation should reflect accordingly. Still it’s great investment training wheels for those that don’t want to learn about investing. Set and forget. Also for a large portion of the population who through their own actions significantly lag the market, anything that keeps them from making an investment decision is probably a good thing.

    6. I like them. I have them for both my 401-k and my wife’s 403b.
      For our IRAs, we use the Vanguard Lifestrategy Growth Fund–I think the Lifestrategy Funds are great too for Retirement accounts.

    7. I’m a big fan of the target date retirement funds. It makes things a lot simpler. However, I think people should probably choose the fund based more on the allocation mix rather than the retirement date. My retirement date is probably closer than the fund I chose because I’m fine with being more aggressive whereas some may want to be more conservative.

    8. Be wary of target date funds, also called ‘funds of funds’. You’ll notice the top holdings inside the target date fund are also mutual funds that have their own set of fees and expenses. Better served to average into an etf(s) or low cost robo than a target date fund in my opinion.
      Other than that, great site, lots of helpful info!

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