Kiplinger Doesn’t Advocate Target Date Mutual Funds

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This is a guest post by Mapgirl, a single, 30-something woman with a mortgage who has all her student loans paid off. She’s outside most of the demographics being written about in mainstream personal finance media. She’s hoping to fill the niche. If you like what you read (I often do), stop by her blog or consider subscribing to her RSS feed.

Recently, I came across an old article from October 2006 Kiplinger about target-date mutual funds, and I agree with most of the arguments in the article about why these funds are aren’t for everyone. Jim recently wrote a devil’s advocate post about index funds, about which you could make some of the same arguments.

First of all, target-date funds are not without risk, and you’ll have to evaluate them on the same basis of performance as you would any other mutual fund. You could stick your money into one of these funds and get a piddly 4% return. If you’re not paying attention, you’ll be screwed when the targeted date comes around with an underfunded retirement. If you decide to go with a target date fund, make sure it’s performing to your expectations like you would with any other investment.

Second, the Kiplinger article points out that these funds are one-stop shopping and are meant to be the ONLY investment in your portfolio. However, if you already have investments, to reallocate them into these funds will have tax fallout. They say it’s probably not a good idea for someone already saving, but a great place to start if you are young in your 20’s. Sure, if you are young in your 20’s and you aren’t inclined to to save, nor to pay attention to retirement saving, then this is a perfectly fine investment vehicle.

The other part I can’t really say better, so let me quote:

The alternative to not remaking your existing portfolio is to undermine the purpose of the target fund. Suppose, to take an exaggerated example, you throw $1 million into a target fund that has three-fourths of its assets in stocks and one-fourth in bonds. But say you have another $1 million socked away in municipal bonds. Presumably, your goal in investing in the target fund is to acquire a portfolio that’s 75% stocks and 25% bonds. But if you keep the munis, you end up with a portfolio that’s 62.5% in bonds and only 37.5% in stocks.

Third, they write that a 55 year old investor is 9 years away from retirement, but the target date fund has only 60% stocks in it so a target date fund isn’t a very good choice. I have a way around that which is to move to the next one with a date in the future which will carry more stocks. I personally like a lot of risk and I would move to the fund designated for people 5-10 years younger than me just to keep a higher level of risk. I’m surprised the article doesn’t mention this as a possible strategy for being in a target date fund when you don’t think it’s holding enough stocks.

The final point of the article is the piece de resistance. They write that most people don’t have the stomach to sit in one investment for 30 years, which is the whole point of these target date funds. I would agree. I couldn’t have just one iron in the fire when it comes to retirement. Seems
kind of a bad idea, but I suppose a fund like this is better than holding onto CD’s or US Treasuries, which is certainly what some people do with their money.

What about you? Can you stomach holding onto one investment for 30 years? Are you in a target fund? Why?

{ 12 comments, please add your thoughts now! }

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12 Responses to “Kiplinger Doesn’t Advocate Target Date Mutual Funds”

  1. The Finance Buff says:

    Sorry about possible duplicates. I have a hard time getting my comments in.

    Articles like this one in Kiplingers are just looking for bones to pick. Nobody says target date funds are without risk. It’s just an easy way of investing in many things at once. Buying a pre-packaged bundle. When you buy a car, you buy a car. You don’t buy your windshield, your trunk lid, driver-side door, passenger-side door, … separately. Mixing a target date fund with other investments is just fine, as long as you know the overall allocation. Getting back to the car example, when you have a car, adding a GPS navigation system or sattelite radio is just fine. And like you said, if Honda Civic is labeled for you but you like a Ford Explorer, go for it.

  2. Debt Hater says:

    I am learning about investing little by little, but even I know that you don’t want one kind of anything in your portfolio. It’s like real estate (location location location), you want to diversify, diversify, diversify! Even if you’re lazy like me and would really just like to invest and leave things alone.

  3. Jeremy says:

    I wrote about this in the past, I didn’t realize there was a Kiplinger article about it as well. But anyway, since I manage a retirement plan and regularly meet with employees to review their account. Our plan offers 5 target date, or asset allocated funds. The problem is that when people are making their fund choices on their own and don’t really know what these funds are.

    I have seen people come in for reviews with their account broken up into 20% of each of the 5 target funds. That makes no sense at all. Then there are others who will be 50% in a target date fund, and then have a hodgepodge allocation of a bunch of other funds creating an overall allocation that is nothing near where they should be.

    Like the finance buff said above, the funds are great, and you can mix and match them with other investments if done properly, but from what I’ve seen is that many investors really don’t have much of a clue as to the purpose these funds should serve in their portfolio.

    Just like any investment, they have to be used properly to be effective. I can’t really say I like or dislike them, but without proper education on the product they could do more harm than good.

  4. Miller says:

    There is another big problem with these target date funds that I’m surprised hasn’t been mentioned. First, these target funds are simply collections of other funds the company offers, right? Well, those are usually actively managed funds with significant expense ratios. Personally, I like low expense index funds, but ignoring that fact, these target funds have to pay those expense ratios PLUS whatever additional overhead for someone “managing” the target fund. You basically get hit with an extra fee. Now, I’ll be fair and say this might be okay for some people. If you want to be so hands off that you just put your money in one fund and not worry about anything (rebalancing, asset allocation, etc.), you expect to pay a premium for someone else to do that. Well, that’s exactly what you do pay. Maybe that’s okay with you, but it’s definitely not okay with me. These guys aren’t doing anything fancy that you couldn’t do simply enough.

    Also, I’ve heard (I can’t support it though) that companies use these target funds to stick money into their “loser” funds. Meaning, if one of their funds needs more principle to play with, they could easily just increase the target fund’s weight in that fund. Maybe this is paranoid, but you can’t ignore its a possibility.

  5. jim says:

    Miller, you can see what the expense ratios are and in many cases the Target fund doesn’t add anything else on top of the underlying expense ratios (this is the case with Vanguard). As for “loser” funds, that could certainly be the case but they divulge what the underlying funds are and you can do your own research to see if they’re padding their losing accounts.

  6. samerwriter says:

    I think a well managed retirement portfolio can significantly benefit from target retirement funds. They’re brainless ways to get a reasonable allocation. I’d bet that most of those who claim they are already allocating their savings are deluding themselves.

    Of course target retirement funds can have a bad year. They’re composed of other investments. If your target retirement fund only returns 4% some year, it’s likely that stock funds returned less that year. The point of a target retirement fund isn’t to beat the market, it’s to manage risk.

    And there’s nothing wrong with a 55-year old being “only” 60% in stocks. That’s pretty close to what most people would recommend.

    A well run TR fund (such as Vanguard’s) is composed of very low-cost index funds, not actively managed funds. So the additional expenses of the TR fund are just about nothing.

    In my opinion, the drawback of the TR fund is if one’s portfolio includes both taxable and tax-advantaged accounts. The naive choice would be to pick similar TR funds in all accounts. But in reality you want your bonds in the tax-advantaged account and the stocks in the taxable account. Getting that with TR funds isn’t possible. In those cases, you can use a TR fund as a guideline, and set up the allocation yourself.

  7. mapgirl says:

    Miller- I’ve never heard that target funds were aggregates of ‘loser’ funds. I kind of doubt that since the funds will still have to perform well and you can’t stick too many bad funds together or else people will pull their money out.

    Samerwriter- I agree, if you go with a well managed company that keeps fees low, like Vanguard and certain Fidelity funds, you’ll probably avoid the problem of high expenses fees. The 12b fee is very important in considering a fund and I see Miller’s point, but I think Jim’s right, you can usually research what funds are in the target fund pretty plainly. (At least from the limited literature I’ve seen.)

  8. Meaghan says:

    I’m in a target retirement fund- Vanguard’s TR 2050 fund. Though I can agree with some of the points the article makes- investors should always do their research before choosing any fund- I can say that for me, having a TR fund has been the best choice. I am just starting out, in my 20s, and there’s no way I could get adequate diversification without some kind of balanced or target fund. This fund doesn’t meet my desired allocation perfectly, and within the next 5 years I intend to add other funds to bring my allocation closer to my target, but for now it acheives the maximum diversification with the fewest costs.

  9. Mission Debt Freedom says:

    I’m not fond of target retirement funds either. I like to have ultimate control over my investments, and not rely on the preferred allocation mix of a fund manager who plugs in my age to determine my mix.

    A lot of 529 plans are moving to this target-date strategy, and get way too conservative early in the game and can’t keep up with the rising costs of college. Great post!

  10. JSH says:

    Several years ago I reallocated my 401k with Fidelity after target funds were added to our options. Since they were a relatively new concept I was a bit skeptical, so I decided to put half my portfolio in the target fund and manage the other half. For my half, I allocated the funds according to the guidelines for my age, which meant about 40% stocks and %10 bonds.

    The last time I checked the target fund comprised about 51% of my portfolio. I haven’t done a thorough analysis, but I suspect part of the difference is that the target fund has more international investments than my half.

  11. Luke says:

    Who wouldn’t like the 15+% return on the Vanguard Target 2045 Retirement account this past year? Yikes…I mean it is an fund of indexes…Is that so hard for folks to fugure out?

    I have this fund in my account as well as other complimenting funds that are NOT covered in the 2045 fund and I thought it was very simple to figure out that if I have $1000 into the 2045 fund, that $719 is in the Total Stock index, that $105 was in the European stock index and so on and so on…If I want to remain balanced with my portfolio goals, I understand to not go out and get MORE regular total stock markey index because I am already covered in the 2045 account…

    This fund holds a solid percentage of market indexes that will not be changed for a decade or more…In addtion to this, you should get small-cap etc. funds as well…

    If they do tuck in a crappy, underperforming fund in the future, which I dont believe Vanguard would do, SELL THE BUGGER!

  12. Bob says:

    Your headline here about Kiplinger not advocating target-date funds is flat wrong. They’ve continually advocated them since 2004. Get your facts straight.

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