Chances are, if you have looked into retirement savings at all, you’ve seen Target Date Funds (TDF) advertised. But what are these funds? And, more importantly, will they actually help you retire on time?
What is a Target Date Fund (TDF)?
Simply put, a target date fund is an actively managed mutual fund. The funds are managed in a way to re-balance, and ultimately move into more conservative investments as the target date gets closer.
The premise is to handle the asset allocation for you, so that you don’t have to worry about complicated investment decisions. You simply pick the year you want to retire, typically in 5 year increments, and the fund handles the rest.
Marketing efforts by major investment industry players, especially over the past 15 years have really paid off. These funds are so popular, that employer sponsored RRSP’s and retirement accounts are almost entirely comprised of these types of funds.
Does the Target Date Fund live up to the hype?
Yes.
And no.
There are several pro’s and con’s to Target Date Funds. Let’s look at each, starting with the criticisms.
What are the issues with Target Date Funds?
While each investment broker will offer a different sales pitch, the criticisms can be broadly broken into three categories.
A One-Size-Fits-All Approach
When you’re simply estimating the date you want to retire, the fund doesn’t take into consideration any of the other factors of your financial health. The most important on this one is your risk profile. While a longer time horizon means you should be prepared to take on additional risk at the onset to reap the return of compounded growth. However, if you are planning to use those funds for another, shorter-term option, like home-buying or education, all of a sudden your risk profile dramatically changes.
Your financial future is as unique as you are. And a target date fund simply doesn’t have the customization to accurately capture your unique needs and desires.
It’s a Competitive Game
Another criticism is that Target Date Funds are not all the same. Even if you picked the same time horizon, let’s say TDF 2035 (15 years from now). Different funds, run by different managers, will carry a slightly different selection of investments inside. This difference in investment options, and the varying mix of debt to equity investments means that each fund performs differently.
In the competitive market of mutual funds, this can lead to poor decisions, and poor returns. This is witnessed as the number of investors who can consistently beat the general market on a somewhat reliable basis is numbered to only a handful of investing professionals. While we’d all like to think the mutual fund manager is Warren Buffet or Ray Dalio, that just isn’t the case.
TDFs: Pay-to-Play
Another criticism of target date funds is that they are a pay-to-play game. Essentially, the offerings you receive are only a small subsection of the entire market. For example, your bank will only offer you fund options that are managed by a related institution.
Many years ago, before I became immersed in the world of personal development, I held a fund with my bank. Looking deeper into the details behind my target date fund, I was not at all surprised to find that the investments held in the TDF were all smaller subsections of other funds sold by my bank. That meant my RBC fund had varying percentages in RBC Emerging Markets, RBC Utilities Funds, RBC US Funds, etc.
What that really means, is that the funds that you see are often covering the ever compounding fees from other mutual funds. And as we’ve previously discovered, even a small change in fees can have a dramatic effect on your total lifetime returns.
On top of that, the selection of funds will be further reduced by the institution that you are working with. This is why many employer sponsored plans aren’t the same across different companies. The offerings aren’t selected for what is best for you, the individual, but based on the rates and admin charges that the company pays to participate.
Knowing this, the question still remains, “It can’t be all bad news, what is the up side?”
The Key Benefit of Target Date Funds
Investing can be complicated.
Actual returns are impossible to predict. And the choices! There are more options in front of you than if you walked down the cereal aisle at the grocery store.
With all those options, in the face of uncertain results, target date funds had the perfect marketing advantage: they were simple to understand.
Someone, presumably an investment professional, will automatically re-balance and reinvest your portfolio with the goal of reaching a retirement date with an appropriate investment mix.
What consumers were really hearing was: Invest here, and you can retire on 20XX date.
The allure of that simplicity, and some misconceptions surrounding how excellent TDF’s are, has helped these style of funds explode into the investing scene in the past decade. Odds are, that if you have investments through an employer sponsored retirement plan, or even if your individual plan was advised by your banker, that you hold a TDF. With the majority of people invested in these style of funds, what do you need to know?
Key Take-Aways: Target Date Funds
TDF’s are convenient, and easy to understand. Investing in them could be exposing you to crippling investment fees. But, the only thing more costly than those crippling fees? Not playing the game in the first place.
Knowing that, it is more important to pick a fund based on the level of fees than the “predicted returns”. Vanguard typically has low-fee options that would serve your needs well.
Target Date Funds are one of the easiest ways to dip your toes into the realm of investing for your retirement. By lowering that initial hurdle, TDFs make it easy to get started on your journey to financial independence. But, because they are a one-size-fits-all approach to investing, you should also supplement your TDF investments with your own investments. This will allow you to play with the lever of asset allocation, and your risk profile, based on the goals that you have. Those individual investments are the bells and whistles on your new car. Same base, but you can customize it to fit your lifestyle.
A low fee TDF, paired with some independent investments, put you squarely in the driver’s seat. It’s your road to financial independence, so the driver’s seat is exactly where you need to be.