If you watch financial advertising, you know that you should spend your days tracking your portfolio, trading frequently, and, well, tracking your portfolio.
Oddly enough, many people find other things that they would rather do in life, such as reading a book, traveling the world, or sorting bolts in the garage. If you’re one of those people, then you probably should invest in a target-date retirement fund.
Unfortunately, you still have some work to do, because some funds are substantially worse than others. But if it all works out according to plan, you should have plenty of time left to do things you like doing better than tracking your portfolio, like watching movies or counting ants.
Target-date funds were designed to fill a need, and that need being giving a reasonable investment for people who wanted to invest for retirement, but had no idea how to do so. Essentially, you pick a date when you wish to retire – say, 2035 – and the fund manager chooses an appropriate mix of stocks, bonds and cash.
Consider T. Rowe Price Retirement 2035 (ticker: TRRJX), which assumes that you’ll be 65 when you retire in 20 years. The fund has about 82% of its assets in stock, 4% in cash, and 13% in bonds. At retirement age, the fund will be about 55% stock and 45% bonds, with the stock portion slowly falling to 20% during the next 30 years.
The T. Rowe approach assumes you won’t turn 65 and move 100% into bonds. After all, you should live another 20 years or so after you retire. The fund’s move from stocks to bonds – called a “glide path” – assumes that you’ll stay invested in the same fund through retirement. Not surprisingly, this is called a “through” approach. Other target-date funds take a “to” approach, and assume that you’ll switch to an income fund at retirement.
As a rule of thumb, the longer you have until you’ll need to spend your money, the more you should have in stocks. Given that, you can assume that longer-dated target-date funds have outperformed those their shorter-dated brethren. And you’d be correct.
Had you invested $100 a month into the average 2020 target-date fund the past decade, you’d have $16,382 now, according to Lipper. (You would have invested $1,200). The same amount in the average 2050 target-date fund would be worth $18,412, because these funds have more stocks in their portfolio.
Those are the basics of target-date funds. What else do you have to know?
Approaches vary widely. Fidelity Freedom 2035 (FFTHX), for example, has 25 holdings – all Fidelity funds. (Most target-date funds are funds of funds, and most choose from their own stable of funds). Vanguard Target Retirement 2035 (VTTHX) has five holdings, all Vanguard funds.
Expenses really matter. Let’s take another look at 2035 target-date funds, and assume you’ve invested $100 a month in each for the past decade. The top-performing fund, T. Rowe Price Retirement 2035, would have a balance of $19,825, according to Lipper.
The worst-performing fund, Fidelity Retirement Advisor 2035 T (FTTHX), would have left you with $17,537. Part of the reason, of course, is return. The T. Rowe Price offering gained an average 7.60% a year, vs. 5.50% annually for the Fidelity offering.
The other part is how much you paid in fees. Fidelity Advisor T shares have a 3.5% initial sales charge, as well as 1.28% in annual expenses, according to Morningstar. The T. Rowe Price fund has no sales commission and 0.75% in annual expenses. The dollar figures above include the effects of sales commissions, if any, as well as expenses.
A few things to bear in mind:
•If you’re a young investor with 30 years or so to retirement, you probably don’t need a target-date fund. Invest in a low-cost, highly diversified stock fund and keep your mitts off it. One good choice: Vanguard Total World Stock Index fund (VTWSX), which invests in just about every stock on the planet and charges just 0.27% a year in expenses.
•You probably don’t need a financial adviser to tell you to use a target-date fund. Why would you pay someone a commission to buy a fund that requires no further effort on their (or your) part? Choose a fund with no commission and let that money work for you, not the financial services industry.
•You shouldn’t put all your retirement money into any one basket, no matter how diversified that basket might be. Consider splitting your retirement funds into two: one for your actual retirement date and another for five or ten years later. Consider using funds from two different fund families, as you never know when a fund’s glide path could make an unscheduled landing.
•The single best thing you can do for your retirement plan is to increase your savings rate. A $100-a-month investment is better than nothing, but you’ll need to increase your savings regularly if you really want to retire.
Financial planners will tell you that a target-date fund is not tailored to your individual needs, and they are correct. On the other hand, many investors don’t need tailor-made advice, nor are their portfolios large enough to interest financial advisers.