Go On A Target-Date

When investing, you should:

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

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

What is that?

A target date fund is a mutual fund designed for retirement savings in which all the 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 you’ll be well-diversified with a mix of US and non-US investments in stock and bond mutual funds.

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.

Also, you’re less likely to be tempted to make changes when the investment markets trigger an emotional reaction inside of you. Instead, you’ll hopefully sense that you’re invested in the right place and there’s nothing to be done to improve things so you’re best off leaving things alone.

My fourth criterion — minimizing your investment expenses — is achieved by selecting a low-cost option. Nearly all mutual fund providers offer a target date option but the cost can vary greatly. You only need to focus on one number:  the so-called “expense ratio.”

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’s worth exerting the effort once to choose a low cost fund.

Which fund should you choose?

For an IRA, I recommend Vanguard’s Target Retirement fund or Fidelity’s Freedom Index fund as the cost difference is insignificant. (Select Fidelity’s “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 the plan administrator. 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.