For Your Retirement Investing, You Should Use A Target-Date Fund

target date fund

When investing your retirement savings, you should aim to:

  1. optimize risk/return trade-off
  2. minimize effort
  3. minimize cost

Unless you’re that rare person who loves to monitor your investments, manually adjust your asset allocation, and avoids any emotionally triggered investment decisions that you’ll later regret, the right choice for your retirement savings is a target date fund.

What is a target date retirement fund?

A target date fund is a specific type of mutual fund designed for retirement assets in which all investors are roughly the same age. You select the target date based on your approximate future retirement date.

Auto-Adjusting Asset Allocation

As your retirement date nears, the fund auto-adjusts the asset allocation (i.e., the mix of stocks, bonds, and other assets) by shifting from more to less risk. For example:

  • a fund with a 2060 retirement date should have nearly 100% of the assets invested in stocks
  • a fund with a 2020 retirement date may be 50% stocks and 50% bonds
  • a fund for investors already into retirement may level off at ~30% stocks.

This is known as the glidepath. The fund should also be globally diversified with a mix of US and non-US stocks and bonds, regardless of the date.

You don’t need to manually adjust your asset allocation and this satisfies my first and second criteria — optimizing your risk/return trade-off and minimizing your effort. This “set it and forget it” approach to retirement savings is appropriate for nearly everyone. If you believe that your situation warrants more or less risk than the norm for your age, you can simply choose a later or earlier target date fund.

Minimizing Investment Fees

My third criterion — minimizing your investment expenses — is achieved by selecting the lowest cost option. You can see the differences among well-known mutual fund firms:

Target date fund operating expense ratios
Fees Vary Greatly Across Different Investment Firms

Vanguard is the lowest cost and best option for your retirement account. Keep in mind that small small differences in fees are quite expensive over long periods. You’re going to save – and add to – these retirement funds for your entire working lifetime so it is worth exerting the effort once to choose the lowest cost fund.

Investment fees are costly over time
Seemingly Small Fees Add Up to Large Amounts

Which investment to choose?

If you have an IRA, I recommend Vanguard’s Target Retirement fund. Fidelity’s Freedom Index fund is a good second choice as the cost difference is insignificant. (Make sure you select their “Index” version as they have a higher cost version that they promote more prominently.)

If you have a 401K, the decision is more complicated because you are at the mercy of the investment choices offered by your employer and fund administrator. What should you do if neither the Vanguard nor the Fidelity target date funds are available? I recommend:

  • Select a low-cost stock index fund and combine it with a low-cost bond index fund, depending on your age. If you also have a low-cost international stock index fund, you should add that to your mix.
  • If neither low-cost target date nor low-cost index funds are available, then your 401K isn’t great and you should advocate with your employer for better selections and lower costs.
  • Depending on your circumstances and if your employer offers a match, you may want to skip your 401K entirely and do a Roth IRA instead where you have the flexibility to invest the funds wherever you choose.

When it comes to your retirement savings, go on a target date. You’ll end up in a long-term relationship.

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