For Your Retirement Investing, Use A Target-Date Fund

target date fund

When investing your retirement savings, you should:

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

Unless you love to monitor your investments and manually adjust your asset allocation, and you avoid any emotionally triggered investment decisions that you’ll later regret, the right choice for you is a target date fund.

What is a target date 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.

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. This is known as the glide path. For example:

  • a fund with a 2060 retirement date should be nearly 100% 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.

Why is it a better choice?

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, simply choose a later or earlier target date fund.

You should also be globally diversified with a mix of US and non-US investments and this addresses my third criterion.

My fourth criterion — minimizing your investment expenses — is achieved by selecting a low-cost option. You can see the differences among well-known financial firms:

Seemingly small differences in fees can be 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.

Which fund should you 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. (Select their “Index” version as they have a higher cost version that they promote more prominently.) Schwab doesn’t have the same experience of either Vanguard or Fidelity in managing these funds so I would not recommend them.

If you have a 401K, the decision is more complicated because you are at the mercy of the investment choices offered by your employer. Most plans now offer a target date fund option but it may not be a low-cost one. If not, consider 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, 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 opt for 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 and commit to a long-term relationship.

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