Target retirement funds are increasing in popularity. The funds, and they may be called “lifecycle funds” or “target date funds” or “age-based funds” or a variety of other terms are mutual funds comprising other mutual funds. The allocation percentages of the constituent mutual funds change as time progresses, theoretically becoming more conservative as you approach your target.
For example, the Vanguard Target Retirement 2050 Fund (VFIFX) is a mutual fund of funds designed for people who expect to retire in the year 2050. You would expect an investment—one that is designed to mirror your investing strategy based on your time horizon—to be quite aggressive in order to make the most of the decades between now and the time you need to access its value.
This reveals the first problem I have with target retirement funds: they are often too conservative. VFIFX contains five other Vanguard mutual funds: Vanguard Total Stock Market Index Fund, Vanguard Total Bond Market Index Fund, Vanguard European Stock Market Index Fund, Vanguard Pacific Stock Index Fund, and Vanguard Emerging Markets Stock Index Fund. As of today, 72% of the fund is invested in the Total Stock Market, 10% is invested in the Total Bond Market, and the remaining 18% is split between the others in amounts hardly meaningful.
I don’t see this as aggressive enough for someone who has such a long time horizon. I would suggest eliminating the bond component entirely and distributing the rest towards the international funds.
My second issue with target retirement funds is how it could lull an investor into a false sense of safety and security. While creating a hands-off approach to investing, it encourages buying and holding which is great for long-term success, but it opens the door to complacency. Your reallocations are on auto-pilot, so if you decide to change your time horizon, you may find yourself under or over-exposed to risk. Also, Vanguard, or which ever management company you choose for your target retirement fund, may decide to change strategies in the future, to the point where their guidelines no longer match your expectations.
Target retirement funds to encompass your entire portfolio. If you’ve chosen the Vanguard Target Retirement 2050 Fund for your entire 401(k) election, but you have a Roth IRA where this fund is not available, then you’re modifying your asset allocation away from that prescribed by Vanguard. If you are comfortable with Vanguard’s exposure to equities in their fund but you decide to invest in VTSMX separately in your Roth IRA, you’ve disturbed your overall asset allocation and opened yourself up to risk you may not have intended for your retirement funds.
Fund managing companies can’t seem to agree on the most appropriate asset allocation for a certain target. I mentioned Vanguard’s current allocation rule for its “2050” fund. Fidelity has a different strategy for those retiring the same year. The Fidelity Freedom 2050 Fund (FFFHX) invests in 68.5% domestic stock funds, 20.9% international stock funds, and 10.5% bond funds. Overall, this is similar to to Vanguard fund of funds, but the specific composition of the international portion provides a strong enough contrast that could have profound effects over 40 years of investment.
The fees for target retirement funds are usually a combination of the fees of the underlying investments. Rarely, a target retirement fund will add a management fee in addition to the feeds already charged by the funds held. Pay attention to these fees, because they will eat into the value of your investment. With a distant target like 2050, the fees eat into your returns even more.
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I agree with your concerns regarding the Vanguard 2050 fund. I have my Roth IRA fully invested in that fund, and, too, would like to see more of an international presence and no bonds. That being said, I am going to keep my Roth fully invested in the 2050 fund until I clear at least $12,000 in Roth assets. That $12,000 will enable me to surpass the $3,000 minimum on at least 4 different Vanguard funds to start my own personal asset allocation. Until then I am happy with the very low fee 2050 fund.
I agree with all your concerns, I never agree completely with the asset allocation chosen by these funds and dislike the extra expenses they layer on. However I think they are very appropriate for people who are completely uneducated or are just starting out and don’t have much to invest.
Even with all their flaws they mostly achieve their purpose, so a complete novice could do a lot worse than picking a TR fund. It’s a solid choice for a novice or uninterested investor to let everything sit in a TR fund for a year while they do their homework and decide what to really do. The alternative is to throw darts at a wall and I’ve seen people come up with some really odd (poor) choices.
Also as Tom described, the fee minimums make it impossible to get your desired asset allocation when you’re first starting out. TR funds are a reasonable compromise to get something pretty close until you have enough invested to implement your desired asset allocation.
I wrote previously about how easy it was to set up my Roth IRA with a Vanguard target-date retirement fund. http://guppielife.com/2008/01/30/how-to-open-a-roth-ira-in-15-minutes-or-less/
I think the important idea to remember here is that these funds might not be ideal for everyone, but they are a WORLD better than not investing at all. Don’t put off investing because you think you need to do months of research first.
Personally, I’m not losing sleep over the fact that my Roth IRA is a little too conservative right now.
I agree whole-heartedly with the first commenter, Tom. I also have my Roth IRA fully invested in a similar fund (Vanguard’s 2045 Target Retirement Fund – VTIVX) and am just diligently waiting to accumulate either $9,000 or $12,000 so I can split my investment up into separate funds.
For the time being, I don’t mind having my money sit in a target retirement fund, but it’s really just a holding place until I have the minimum needed to diversify a little further.
Very informative post, thanks Flexo.
I am using this type of vehicle for my deferred comp but I bumped up the target from to keep it from being too conservative. The fund doesn’t know when I am going to retire.
My 401(k) started offering target funds this year. The expensive ratio for the 2050 fund is .65 percent and .54 percent for the 2005 fund. My plan does not show the real name of the fund, but the name of the fund management company is AllianceBernstein L.P.
I’m going to wait a little while before I move my money into the target funds to see whether I can beat them with my own mix.
So far, I’m losing, lol.
All I have to say is it could be worse, a lot worse. TRFunds are decent choices for people interested in a “set it, forget it” approach and, although conservative, give good diversification.
For me, like some of the readers above, I’m just waiting for enough money to transfer to other funds…...TRFunds come in handy when you’re just starting out.
Anyhow, thanks for the thoughts. Gives it another angle to look at.
If you think “your” retirement year fund is too conservative, you could just invest in a TRF 5 or 10 years earlier than your expected retirement. That is what I did. Obviously when you get closer to the date of the fund, you’ll want to evaluate leaving it or splitting it out.