Many workplace retirement programs have a target-date fund, and many financial professionals advise workers to put money in them. Do target-date funds belong in your retirement plan?
What Is a Target-Date Fund?
The idea of target-date funds is great—and that’s probably why they make up nearly $800 billion of retirement assets.
Most Americans know very little about investing, but that’s not their fault. Imagine somebody sitting you down in the cockpit of a commercial airliner without any training and saying to you, “Fly me to San Francisco.” Building and managing an investment portfolio that will result in an appropriate retirement nest egg in 30 years is the financial equivalent of flying a commercial airliner for most Americans.
That’s one of the reasons target-date funds were invented. All you have to know is your approximate retirement date. If you’re 30 years old, you would likely pick a 2050 or 2055 target-date fund. From there you deposit your retirement money into that fund and let it go to work. It’s really that simple. All of the changes that need to happen with your investment portfolio as you get closer to retirement will happen without you taking an active part.
Target-date funds are simple. People who work full time and have a family and other responsibilities can be confident knowing that as long as they divert enough of their monthly income to retirement, the fund will do its job. It’s a set-it-and-forget-it model.
In addition, these funds don’t require financial advisors. The beauty of a target-date fund is the team of investment professionals running it behind the scenes. Although they haven’t met you, they are your financial advisors.
Investing in target-date funds comes with a fee because a company has to manage them. That fee can be pretty steep. Morningstar is the go-to company for information on many investment funds.
Of the 2,200 target-date funds it tracks, the average expense ratio is 0.903 percent. That means you will pay $90.30 for every $10,000 you have invested each year.
Contrast that with other kinds of funds that stand between 0.14 percent and 0.16 percent; you can see the large difference in cost. With those funds you will only pay up to $16 per $10,000. If you’re in a company-sponsored 401(k) or other account where your choices are limited, you might be stuck paying high fees, because all they offer are the high-priced funds.
Outside of fees there are other problems with target-date funds. Some perform better than others. A quick look at Morningstar’s list of 2055 target-date funds reveals a three-year performance of around five percent to above eight percent. Although it might not seem like a large difference, that could actually represent hundreds of thousands of dollars. Again, unless you’re in a retirement plan outside of your company, you may only have one choice.
Finally, some argue that target-date funds are out of date now that robo-advisors exist. Companies such as Betterment can manage your portfolio automatically for a fraction of the cost of a target-date fund. However, because they have yet to be tested in down markets, many professionals advise against trusting these platforms. Still, Betterment makes a compelling case.
No Excuse for Inaction
Your retirement is the most important financial goal you have, so taking a hands-off approach is not an advisable plan. That said, life is busy, and a target-date fund is better than doing nothing.
There are, however, cheaper ways to manage your money. Low-cost index funds or ETFs also provide a version of a set-it-and-forget-it model. As you age and your account grows, getting the help of a financial advisor is your best course of action.