In general, I believe there’s more to like about target-date funds than dislike. However, several recent articles have taken such funds to task. Let’s see if the criticisms are warranted.
A little background
Target-date funds greatly simply the process of choosing an appropriate mutual fund, getting the important asset allocation process mostly right and automating the chore of making your portfolio more conservative as you get older.
All you have to do is choose a fund with the year of your intended retirement as part of its name and that fund will provide the stock/bond mix the fund company believes is appropriate for someone your age. As you get older, the fund will automatically change that mix, dialing down exposure to stocks and increasing exposure to bonds.
That simplicity is the main reason why target-date funds have become the most popular choice within retirement accounts such as 401(k) plans (along with the fact that many workplace retirement plans automatically put investors in such funds).
My issues with target-date funds
The main problems I’ve had with target-date funds are that many people are not aware of how different one fund family’s stock/bond mix can be from another (See How Well Do Target-Date Funds Perform in a Downturn?) and that most such funds are too conservative. To that second point, I see no reason why investors in their 20s should have any of their portfolio in bonds or cash. And yet, target-date funds designed for such investors from Fidelity, Vanguard, Schwab, and others have anywhere from 5% to 10% of their portfolios in those conservative asset classes.
Other people’s issues with target-date funds
A recent Bloomberg article criticized target-date fund fees, noting that the average expense ratio of such funds is 0.67. That means for every $1,000 invested in such a fund, $6.70 will be used to help cover the fund’s operating and marketing costs. The article argued that investors could relatively easily build a similarly structured yet lower cost portfolio on their own using index funds. The article also took issue with target-date funds for being too conservatively structured, as I noted earlier.
Joining in the criticism was the Motley Fool, which also called out target-date funds for being too conservative and too expensive. But it also highlighted an additional issue — that a one-size-fits-all asset allocation approach based strictly on an investor’s age is going to miss the unique needs of various people within each age group. Some may need to structure their portfolios very differently based on what other investments they have, their risk tolerance, and other factors. This is the same issue highlighted by a recent CNBC article.
Again, I think target-date funds serve a useful purpose, especially for newer investors looking to easily build a portfolio that gets more things right than wrong. Of the various other people’s issues raised above, the Motley Fool’s point about the shortcomings of one-size-fits-all portfolios is especially noteworthy. For older and/or more conservative investors who may be concerned about the next downturn, Sound Mind Investing’s Dynamic Asset Allocation strategy will likely offer better protection than even the most conservative target-date fund. And for those looking for a more powerful all-weather portfolio, 50/40/10 is worthy of consideration.
Do you have money invested in a target-date fund? If so, what are your thoughts about the issues listed above?