Adding Target Date Funds to Your Portfolio

by Scott Sery on August 8, 2012

One of the biggest drawbacks people have about saving for retirement is they just have no idea where to put their money.  They know they need to be saving, but building a good portfolio usually takes some effort and knowledge.  Even after the portfolio has been built, they must manage it, rebalance it, keep track of the investments, and will need to reallocate as they start approaching retirement.  In order to take the stress out of investing for retirement, many fund families have started to offer target date funds as an alternative.

Target date funds came onto the scene in the early 1990’s.  Throughout the past 2 decades they have gained popularity.  The funds are a conglomerate of other funds offered by the company.  They are set up to be conservative to aggressive depending on how far away retirement is.  So a Target Date 2015 fund would be much more conservative than a Target Date 2040 fund.  As these funds gain popularity, most people who are enrolled in a 401k will often be automatically put into a target date fund due to how easy they are to use and manage.  While they are excellent ways to accumulate money, they do have their ups and downs.

The biggest benefit of the target date fund is the investor does not have to worry about asset allocation.  They can simply pick the date that is closest to their date of retirement, and then allow the fund company to do all the work.  The funds will rebalance automatically, so the investor does not have to worry about becoming over-weighted in stocks or bonds, and they are designed to become more conservative as the investor approaches the target date.  With just one fund in the portfolio (technically that one fund is made up of many more funds), a portfolio overview is quick and easy.

The drawback of these funds is that the internal expenses are higher.  There is a lot more work being done by the fund family to maintain them, so they need to charge a higher internal expense ratio to offset their costs.  As a result, there is a slightly smaller return on investment.  While the target date fund is actually widely diversified, many people become uncomfortable with just one fund in their portfolio.  Therefore, they will often want to keep just some of their money in the target date, and manage the rest in other funds.  This can be helpful since some of the target date funds will become too conservative too quickly.

For those who just want to plan for retirement, these funds are a great way to do so.  With many of the major fund families, such as American Funds, Vanguard Funds, and Oppenheimer Funds, offering them for their retirement clients, there is no reason anyone should be able to use the excuse that they were not available.  The higher expense associated with them is justified in the sense that the portfolio is easy to manage, simple to follow, and the worry about rebalancing is negated.

Do any of you invest in Target date funds?

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Scott Sery

Scott Sery is a native to Billings, Montana. Within an hour in nearly any direction he can be found fishing, hunting, backpacking, caving, and rock or ice climbing. With an extensive knowledge of the finance and insurance world, Scott loves to write personal finance articles. When not talking money, he enjoys passing on his knowledge of the back country, or how to live sustainably. You can learn more about Scott on his website ScottSery.com
  • http://getworth.blogspot.com/ K @ Get Worth

    I’m a big fan of target date retirement funds. I have Vanguard 2050 for my Roth IRA and Fidelity 2050 for my 401(k). Good point about some of them having higher expense ratios. I’d recommend Vanguard for those that have a choice because the expense ratios are so low, even with target date funds. My Vanguard is .19% versus .77% with Fidelity.

    It’s nice setting these retirement accounts on auto with these funds. Then any additional diversification I want to do can be done in a brokerage account.

    • http://www.onesmartdollar.com/ Sean @ One Smart Dollar

      Agreed. I have part of our retirement accounts with Target date funds. Vanguard by far has some of the best expense ratio of all fund companies

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