Should You Use Target Retirement Funds? – Pros and Cons

Target date funds are a new innovation on Wall Street, a product designed for convenience and easier retirement planning.

A target retirement fund is one which builds an asset allocation mix based on a retirees expected retirement date. Over time the fund makeup changes to moderate the portfolio’s risk as the future retiree gets closer to their ideal retirement date. Let’s look at target retirement funds and lay out the pros and cons.

target date retirement funds
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Pros of Target Retirement Funds

Here are the main advantages to target retirement funds:

  1. Automation – A target retirement fund automates asset allocation decisions. Each year, the portfolios are also rebalanced to return to their target allocation going forward.
  2. Availability – Target retirement funds are everywhere. Virtually every 401k sponsor and brokerage firm carries a target retirement fund for investors.
  3. Tax efficiency – When based on index funds, target retirement funds are very tax efficient as there are only a few transactions that would pass on taxes to fund investors. Keep in mind that taxes only matter when funds are held outside of a tax-sheltered retirement account.
  4. Simplicity – Never has investing been easier than simply picking a target retirement date and making automatic contributions. There is no need for analysis paralysis – a simple list of choices encourages many more people to invest who might not otherwise if they had to make their own selections.

You probably notice a trend in the advantage above. A target retirement fund makes retirement planning easier, more convenient, and automated. The major advantage is the ease at which someone can start saving for retirement.

Cons of Target Retirement Funds

A full analysis requires consideration for the downsides of target funds. Here are some of the disadvantages:

  1. Fees – Some target date funds are packed with fees. As target funds are funds of funds (a mutual fund or ETF that holds other mutual funds and ETFs), investors are hit with double fees.
  2. One size fits all planning – We are all different. Our finances are very different. A target date fund does not take into consideration key retirement factors like home equity, existing debt, or other assets and liabilities that you have outside of the fund.
  3. No side benefits – You pay for financial advice in one way or another. When you hire a financial planner, you pay commissions or fees for advice on matters that extend beyond investments and into insurance, estate planning, and taxation. You don’t get the same advice with a target date fund that you might get for a similar price from a financial planner.
  4. Less useful for people closest to retirement – A target retirement fund is a “good enough” way to save, not “the best” way to save. As your savings grow and you near retirement, it makes much more sense to seek professional advice for your individual situation than to accept the one size fits all approach to planning.

The primary disadvantage of a target retirement fund is that it makes decisions based solely on when you wish to retire. A proper financial plan is formulated from far many more variables than the date at which one wants to enjoy life without working.

Should You Use Target Retirement Funds?

I’m a big fan of low-cost target retirement funds for people who are just starting the process of saving for retirement. When you have a less than substantial amount of savings or net worth…say, less than $100,000, it would be difficult if not impossible to add to performance after costs by paying higher commissions or flat fees to a financial planner.

There is a point at which hiring a financial planner to independently assess your situation and your finances makes economic sense to the extent that you get more finely-tuned planning at a lower relative price. Seeing as fee-only financial advisers charge by the hour, or as a fixed percentage of assets based on how much you invest, it makes sense to hire a planner for “hands-off” planning when you have accumulated a significant net worth. A net worth of $100,000-250,000 seems like a good ball park number for moving to individual advice.

Another Useful Resource

If you are looking for a great tool to help manage your investments, try using Personal Capital. It allows you to view all of your investing and banking accounts in one place. I personally use Personal Capital to keep track of my portfolio and it makes everything so much easier. Not only can I see the changes in various investments, but I can track my net worth. In the past few months, it has saved me hours of time and helped me make smart investing decisions.

11 Responses to Should You Use Target Retirement Funds? – Pros and Cons

  1. Although I have not used target retirement funds, I recommend them to people who are seeking a passive approach to retirement. Most companies are offering these in 401K as an option, so it easily accessible to you.

    • Yeah, I would have no problem recommending them to people with the understanding that there comes a time when investors should transition to something more tuned to their particular individual needs.

  2. So far we’ve used mostly Target funds in our retirement accounts – although I have a meeting with a FP later this week to look at some of our other options.

    People are quick to criticize fees, but not all Target funds have the same fee ratios. I recommend that people look into Vanguard’s which are significantly lower than most others.

    • The variance in fees is high. Of course, Vanguard is really inexpensive, but it’s not an available choice in smaller 401k plans. Other fund companies tack on 1.5% or more in fees on top of funds with fees of 1-2% per year. That kind of fee is ridiculous, which is why target date funds draw a lot of criticism.

      I hope your meeting with a financial planner goes well!

  3. Good comparison. Not all are packed with fees, but enough are that it does warrant closer inspection if you go into them. My main concern is your Con #2. We’re all different, and thus often times a TD fund will not be the best fit for you as an investor when you look at all involved. I think they can be good, but as with any investment, you need to do your homework and make sure it’s the best fit for you.

    • Yeah, I think that’s the biggest problem – retirement date is just one of many variables that go into asset allocation. It’s hard to believe that someone who has 20 rental homes and a smaller exposure to the financial markets would need the same allocation as someone with millions in the financial markets just because of their expected retirement date. One size fits all works pretty well, until you’re no longer that one size.

  4. We have used target dates funds exclusively to date and I don’t believe we’re paying higher fees (Vanguard) but I’ll check on it. I like that I don’t have to do any rebalancing. However, it seems that no matter how young you are Vanguard only does 90% in stocks and I actually might want to be a bit riskier. Maybe I will switch to a mix of ETFs when my net worth is a bit higher like you suggested. I’m very concerned about reducing fees/load over the long term.

    • If you’re in Vanguard funds you’re probably not paying that much more in fees – not a noticeable amount, at least.

      Target retirement funds got a lot of criticism during the financial crisis for their allocation. The problem reverts back to a common concern – we’re not all the same. Someone with $10 million saved who plans to retire in 2020 has entirely different needs than someone who has $500k saved with the same expected retirement date.

      Does your 401k/IRA sponsor have a broker window? If so, you should be able to buy Vanguard’s ETFs through your retirement account to dial up your stock exposure.

  5. They’re good for me while I’m in my 20’s and I will monitor them as they start becoming more conservative. I actually have funds with very low fees from Vanguard and in my 401k and it makes things much easier and likely are what I’d invest in otherwise. Plus, I don’t have to re allocate my assets when some out perform others.

  6. I see the pros of such funds, and also see the less favorable aspects. It’s a topic I’ve written about, and tend to think that it really depends on the comfort level people have with handling their own investments, as well as the complexity of their own situation. People just starting out can be good targets (no pun intended!) for such funds for a variety of reasons.

  7. I highly recommend target retirement funds to people who have not clue, want to do it themselves and are going to be learning about asset allocation in the mean time There are a lot of pros and cons when you use the target retirement fund, but they are better than not investing at all!