Target date funds (also called Lifecycle Funds) are popular among DIY investors. With low minimums providing easy entry and a “fire-and-forget” holding strategy, an investor can purchase a Target Date Fund and conveniently forget about it for the next 20-30 years.
How do Target Date Funds work?
A target date fund is a mutual fund that has an expiration date (sort of). For example, the American Funds 2030 Target Date Retirement Fund® Class C suits an individual who will retire in or around 2030. The American Funds 2065 Target Date Retirement Fund® Class C is for younger folks who are a long way away from retirement. The target date usually comes in five-year blocks, so you probably won’t find one that has 2042 as a retirement year, for example.
The gist of the target date fund is that the farther from its target date, the more aggressive the fund will be. That means more stocks and fewer bonds. As the fund gets closer to its target date, its fund manager reallocates assets to more bonds and fewer stocks. This reduces the blow a market downturn would have on a stock-heavy portfolio nearing retirement.
Different target date funds may have different risk profiles. This means that a more conservative 2060 target date fund would have, for example, an 80% bond/20% stock asset allocation in the year 2055 while a more aggressive one would have a 60% bond/40% stock allocation. If you decide to purchase a target date fund, pay close attention to this factor to ensure it fits within your defined risk tolerances.
Are target date funds right for you and your portfolio?
Maybe. But there are some serious cons you shouldn’t overlook when deciding whether or not to purchase a target date fund.
Potentially High Fees
A target date fund’s fees may be quite high. Since these are buy-and-hold funds, those with high expense ratios and annual operating costs could end up costing you tens, if not hundreds, of thousands of dollars over the long run. To use The American Funds 2065 Target Date Retirement Fund® Class C as an example: it currently has an expense ratio of 1.45%. If you hold it for more than ten years, the expense ratio goes down to .73%. Assuming you put $10,000 down as an initial investment this year and invested an additional $12,000 each year until 2065 and had a 6% rate of return, you would pay $474,698.34 in fees!
Using the exact same investment horizon, rate of return, and contributions, the Schwab Target 2065 Index Fund with an expense ratio of .08% would cost you only $57,525.25 in fees. Of course, if the American Funds TDF performs much better than Schwab’s, it may be worth it to pay those extra fees. But it would have to perform much, much better to make up for a $420,000 difference!
Inflexibility
Target date funds are a one-size-fits-all, cookie-cutter approach. It doesn’t take into account your unique situation, such as changes in income, employment status, or desire to retire earlier or later due to changing life circumstances.
target date funds vs customize retirement plans
A customized retirement plan factors in the above-mentioned, plus provides an all-encompassing strategy that includes tax optimization and harvesting, order of withdrawal and withdrawal advice, and estate planning all while making sure the plan is flexible enough to deal with life’s uncertainties. At the end of the day, a target date fund may have a place in your portfolio – but it shouldn’t be the backbone of anyone’s portfolio.
Give us a call to discuss your personal retirement plan!
