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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