Thanks to advances in technology, you have numerous investment options right at your fingertips. Beyond the constant emergence of new investing platforms, investment selection is also evolving. Target-date funds are a prime example of an easy solution for the DIY investor. But more and easier, in any regard, doesn’t typically equate to better.
Here’s how the Financial Industry Regulatory Authority (FINRA) defines a target date fund: “Target-date funds are designed to help manage investment risk. You pick a fund with a target year that is closest to the year you anticipate retiring, say a "2050 Fund." As you move toward your retirement "target date," the fund gradually reduces risk by changing the investments within the fund. That said, target-date funds are not risk-free, even when the target date has been reached.”
What’s not to like? It’s a set-it-and-forget-it way to invest based on your anticipated retirement date. While it looks great on the surface, here are points to consider before heavily investing in a target-date fund.
Retirement Planning Is Not One-Size-Fits-All
Target-date funds are growing in popularity because they’re simplistic in nature. Nearly every 401k plan offers a target date option. But consider the following 2 people:
Person 1: Goal retirement year of 2050. 6-figure income, self-employed, invested in real estate but wants to unplug and move to the beach once retired.
Person 2: Goal retirement year of 2050. $50,000 income, consistent 401k contributor. Enjoys being active and plans to find a stress-free part-time job once retired and will stay put to live by family.
While these 2 people are working under similar timelines, they have very different goals for their retirement years. If shopping for a target-date fund, they may land in the same one. One-size-fits-all retirement planning is not realistic. And it’s likely neither would reach their full potential, financially, by utilizing a target-date fund strategy.
What’s Not Accounted for in a Target-Date Fund?
What if you’re investing and saving outside of your target-date fund? A target-date fund does not consider other investing measures. This means it’s assuming all your eggs are in one basket, which may not be the case.
Risk tolerance is another important aspect when creating an investment strategy. While target-date funds are re-balanced and diversified to mitigate risk — whose risk tolerance do they base decisions on? Unfortunately, it’s likely not yours.
A person with extensive knowledge of the stock market will likely be ok with taking on more risk than what a traditional target-date fund prescribes. This is due to the historically cyclical nature of the stock market — if you play the long game, the odds are highly in your favor to come out ahead when you review the history of the S&P 500.
The fact of the matter is, your whole portfolio is not taken into consideration when utilizing a target-date fund. While they may be ok for young investors not actively managing the account, as the balance rises, it’s smart to review all of your options.
Watch Out For Fees
A target-date fund changes over time. While the account may start heavily invested in stocks, over time risk is diverted by allocating more funds to bonds. This helps assure your funds will be there when you’re counting on them.
It’s important to understand the management aspect of a target-date fund does come with fees. Many hover around an expense ratio of 0.51% but some are over 1%. With an expense ratio of 0.51% and a balance of $100,000, you would pay $510 in fees per year.
Fees lower than 0.51% are certainly obtainable, and it’s important to review fees with a financial advisor because they vary for unique reasons. It’s easy to brush off such a small number when in reality, fees can easily add up to thousands of dollars each year as you near retirement.
We want to take a moment to distinguish that Integrated Wealth Management is a fee-only firm. That is not to be confused with the fees we just described. We charge a percentage of assets fee for our retirement planning and wealth management services. We send a quarterly invoice for our fee so you are informed. The mutual funds you invest in will have their own fee as we discussed above. We only receive the fee we invoice you. Some advisers receive a piece of your investment in a mutual fund through a 12B-1 fee. What Is a 12B-1 fee? A 12b-1 fee is an annual marketing or distribution fee on a mutual fund. And is included in a fund's expense ratio. This fee is paid to the advisor but you may never realize it. This is why it is important to look at all the internal fees of a mutual fund. So you can compare apples to apples.
We’re also fiduciaries — meaning we put your needs and best interest ahead of our own. We proudly highlight this because it’s simply who we are. Our ethical standards drive us to produce the best results for every client, with no ulterior motives.
Lack of a Clear Plan
On the topic of best results, you still want your retirement account to grow once you’re retired, right? It's not as if you’re cashing out the day you clock out. With an average life expectancy of 78.99 years, Americans have an average of 13+ years to plan for post-retirement. You could miss out on a lot of growth potential if your target-date fund drastically pulls the reins on risk.
At the end of the day, a target-date fund doesn’t take the time to get to know you, understand your family dynamic, realize your goals, or provide compassion when life's inevitable lemons come your way. When you build a portfolio with a financial advisor that you know and trust, you gain confidence and clarity around your financial future.
Overall target-date funds are a little too good to be true. Our goal is to provide the knowledge that empowers our clients to make confident and sound financial decisions. If you’re currently relying on an electronically managed fund to do the job, consider taking a second look.
We’d love the opportunity to get to know you. Our Delaware based advisors are available for a complimentary call to review how our services can benefit your retirement planning efforts.