Target Date Funds: Clark’s Favorite Retirement Investment

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Target date funds are the “easy button” for retirement investing. They can take the confusion and research out of investing and let you get back to your life.

Money expert Clark Howard recommends target date funds as a strong investment choice for most people. But why does he like them so much, what are they and how do they work?


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What Is a Target Date Fund?

A target date fund is the ultimate set-and-forget retirement investment.

Also called “lifecycle” or “target retirement” funds, they make investing easy. You can put every dollar you’re investing for your retirement into a target date fund and be completely done with it.

In plenty of cases, your investment will even perform better in the long run than those that belong to people who spend hours a day obsessing over the latest market opportunities.

“With target date funds, you don’t have to do a thing other than invest your money. It could be the best and easiest investment choice you ever make,” Clark says.

“You just pick the year closest to when you think you’re going to retire and you just slap all the money you’re saving into that choice.”

Target date funds are the default choice of many workplace retirement plans, especially 401(k) plans that auto-enroll new employees.


How Does a Target Date Fund Work?

Target date funds include years in their names. For example, “Schwab Target 2065 Index Fund” is designed for people who plan to retire somewhere in the vicinity of 2065.

Your first step: Pick the target date fund with the year that’s closest to when you think you’ll retire. Don’t stress too much about this choice. Just make your best estimation.

These funds typically are five years apart. For example, Vanguard has active target date funds for 2015, 2020, 2025 and so on, all the way to 2065.

You can put every dollar you’re investing for retirement into your target date fund. Doing so removes two major investing tasks from your plate.

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First, target date funds provide diversified investment portfolios. Investing this way means you won’t have to figure out the right mix of stocks and bonds.

Second, target date funds rebalance your portfolio over time. The closer you get to retirement, for example, the more conservative your target date fund investments will become.

If you’re managing your own investments, you’ll need to rebalance your portfolio periodically based the relative performance of different elements inside it. If the stock market has an incredible two years, for example, it may cause the percentage of your portfolio that’s in stocks to shoot upward. Target date fund managers take care of all that for you.

What Is a Glide Path and Will I Always Hold Stock?

The plan to slowly remove risk from your portfolio as you get closer to retirement is called a “glide path.” At some point, your target date fund will reach its final, most conservative form and then lock in its asset allocation.

There are two types of target date funds. Those that glide into the most conservative portfolio mix on the target date are considered “to” funds. Those that extend the glide path to a point in the future that’s past your target date are called “through” funds.

Target date funds typically hold some of your money in the stock market even during this final allocation. That way inflation doesn’t chew up your retirement savings too quickly.

Keep in mind, though, that if you invest in other things, it will have an impact on your overall portfolio allocation.

For example, if your target date fund invests 10% of your total portfolio in bonds, but you put an additional 20% of your overall portfolio into bonds outside of the target date fund, your portfolio will contain 30% bonds overall.

What Investments Are Inside Target Date Funds?

The typical target date fund will be focused primarily on these assets:

Different target date funds often offer similar portfolios. They generally move from aggressive to conservative, shifting toward more fixed income such as bonds the closer they get to the target dates attached to them.

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But the exact portfolio allocation and glide path differs from company to company — sometimes even from option to option within the same company (example: Fidelity).

Target date funds can also be passive (very little trading inside the fund) or active (lots of trades).


Target Date Funds Are for (Nearly) Everyone

Clark thinks target date funds are great choices for almost everyone.

That’s especially true because of their simplicity. In some situations, you may do better long term  by following a different strategy. But that requires extra time and understanding to get that extra value.

Historically, the return you get with target date funds is perfectly acceptable. It’s the right choice for the typical person, Clark says, because most of us are willing to hit the “easy button” and feel good about a proven strategy with little long-term risk and effort.

If you fit into one or more of these categories, there’s a great chance that you’ll be very happy investing in a target date fund:

  • You appreciate simplicity.
  • Your risk tolerance is typical for your age group.
  • You’re on board with investing for the long term.
  • You have a 401(k) plan or an Individual Retirement Account (IRA).

When Target Date Funds May Not Maximize Your Returns

If you’re 25 years old and plan to retire in 40 years, putting 100% of your portfolio into equities (as opposed to 90%, which is where many target date funds would have you) is totally fine — perhaps even preferable.

But investing in a target date fund through a taxable investment account rather than a retirement account such as a 401(k) or IRA could be problematic. That’s especially true if you’re getting close to retirement and making a good income. The target date fund will reallocate your funds into more conservative investments, which can add to your tax bill.


Advantages of a Target Date Fund

Here are some of the biggest positives about target date funds:

  • Diversified portfolio. You get exposure to a number of different investment classes — stocks, bonds, mutual funds — without needing to buy each of them individually. Talk about making life easier!
  • Age-appropriate allocation. You’re outsourcing the decisions, research, judgment and execution. By design, this type of fund usually ensures that your portfolio will be appropriate relative to how many years you are from retirement.
  • Automatic rebalancing. This is an extension of the last point. The target date fund manager(s) will shift your portfolio over time as you get closer to retirement. That lifts a substantial load off your back in the long run.
  • Protection from emotional decisions. If you’re passing the burden of your investment decisions along to the manager of the target date fund, perhaps you’ll be less likely to panic sell when the market declines. Those types of fear-driven trades can lead to negative outcomes, so anything that helps prevent that from is positive.

Disadvantages of a Target Date Fund

Here are some of the potential downsides to opening a target date fund.

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  • May be more conservative than optimal. As I mentioned earlier in the article, the textbook answer for the most optimal investing strategy when you’re several decades from retirement calls for a slightly more aggressive portfolio allocation. However, the difference between that textbook answer and what you’ll get within a target date fund isn’t egregious or far-fetched.
  • Retirement prediction can change. Especially if you invest in a target date fund early in your career, it’s possible that your retirement date could be considerably sooner or later than you originally anticipated. This could put your portfolio allocation a bit out of whack.
  • One size does not fit all. Some target date funds are more active or passive, more or less risky or reach their final, most conservative allocations sooner or later. Finding the target date fund that fits you best may require a bit of research. One person may be totally OK with just fixed income once they reach 65 years old, while another may need a higher exposure to equities for a longer time period in order to fund their retirement.
  • Some options aren’t cheap. Depending on how a specific target date fund’s portfolio is structured, it could be a “fund of funds.” If that’s the case, and your target date fund invests in a number of active mutual funds, for example, you’ll pay a fee, or expense ratio, to the managers of each of those funds. That’s in addition to paying the manager of your target date fund. Clark is a fan of passive, index-tracking funds, which tend to be much less expensive.

Clark’s Target Date Fund Recommendations

As with most investing choices, Clark recommends starting with the Big Three when searching for a target date fund: Vanguard, Fidelity and Schwab.

When you start investing in a target date fund can make a huge impact on performance. If you enter a fund many decades from the associated target year, you’ll get exposure to equities for a much longer period of time.

These funds often perform better in terms of annual return the further they are from their target date due to more aggressive portfolio allocation.

Here are more details about the target date funds at each of the “Big Three” companies.

Vanguard’s Target Date Funds

  • Expense Ratio: 0.12% to 0.15%
  • Years Available: 2015 to 2065

Vanguard makes investing in a target date fund as simple as possible.

All of Vanguard’s target date funds are named “Target Retirement” with the year at the end of the name such as “Target Date Retirement 2055.”

Fidelity’s Target Date Funds

  • Expense Ratio: 0.12% to 0.75%
  • Years Available: 2015 to 2065

Fidelity makes selecting the correct target date fund somewhat tricky.

Its Fidelity Freedom 2045 Fund, for example, charges 0.75% annually while returning 7.71% since its inception. Its Fidelity Freedom Index 2045 Fund (notice the slight name difference?) charges 0.12% annually while returning 10.87%.

Naturally, Fidelity puts its Freedom Funds (no “index” in the name), which charge much higher fees, out front. However, in many cases, the cheaper Freedom Index Funds outperform their Freedom Fund counterparts.

Schwab’s Target Date Funds

  • Expense Ratio: 0.08% to 0.74%
  • Years Available: 2010 to 2065

Schwab makes it somewhat difficult to find and evaluate its target date funds.

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I was able to pull up a full list of the funds on Schwab’s website, but it took me more than a few times looking at this page before I realized they were there (keep scrolling if you don’t see them).

Like Fidelity, Schwab offers two sets of target date funds: Schwab Target and Schwab Target Index. Schwab Target funds charge up to 0.74% per year. Schwab Target Index funds charge just 0.08% per year and often outperform their counterparts.

What To Consider When Evaluating a Target Date Fund

Once you’ve chosen a target date fund, investing is as easy as putting all your retirement savings into it. However, picking the right fund can take a little work.

That’s assuming you have options. If you’re investing through a 401(k) plan, for example, you may not have a choice of provider. But if you do (for example, if you plan to open an IRA), here are some things to consider when you look for the right target date fund.

  • Cost. The annual expense ratios of target date funds — the amount that the fund managers charge you in fees per year — varies wildly. You’ll find target date funds that charge less than 0.1% and some that climb to around 1%. In the long run, the amount you pay in fees can save you (or cost you) tens of thousands of dollars.
  • Fund strategy and allocation. This is an extension of cost in many ways. But a target date fund can be passive or active. It can feature more or fewer equities. It can favor index funds or individual stocks.
  • Impact on your overall portfolio. If you invest every dollar into a target date fund, you don’t need to worry about proper diversification. However, if you make investments outside of your target date fund, consider what your overall portfolio looks like. Depending on what those outside investments are, your overall portfolio including the target date fund holdings could be too conservative or too aggressive.

Clark’s Alternate Way To Invest

If you find target date funds too boring, or if you’re trying to invest outside of a tax-advantaged retirement plan, you may want another option.

Clark thinks that dividing your portfolio between the following types of index funds is also a sound way to invest:

  • Total stock market fund
  • International fund
  • Bond fund

Final Thoughts

Investing can be counterintuitive. Often, a simple, balanced, steady approach wins in the long term ahead of an active approach that’s always chasing the flavor of the day.

Investing in a target date fund is the easiest way to get a diversified portfolio with an age-appropriate allocation without having to do anything but put money into it.

Target date funds are great choices for a large number of people. However, each person’s circumstances and financial goals are different.


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