Do Target-Date Funds Miss the Mark?

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?

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6 Responses to Do Target-Date Funds Miss the Mark?

  1. Pam L. August 16, 2018 at 5:27 PM #

    About the conservative nature of some plans, the stat referencing someone in their 20s having 10% in bonds stuck in my head. I just checked my statement to confirm my recollections about my plan, and the fund I’m in at an age just north (ahem) of 50 only has 10% bonds in it. So holy cow, a fund with 10% bonds for a 20-something is crazy!

    • Matt Bell August 16, 2018 at 6:39 PM #

      Yeah, I agree. I think someone in their 20’s has no need for bonds or cash in their investment portfolio.

  2. Pam L August 15, 2018 at 9:28 PM #

    I have my 401(k) invested in two different target date funds–because my retirement goal date sits smack dab in the middle of two of our plan’s options. Our plan has relatively low fees, and I like the simplicity of not having to worry about rebalancing, but as I get closer to retirement, I’m wondering if I should stop being lazy and switch to index funds and annual rebalancing like I used to do back in our ACN days. Lots to think about.

    • Matt Bell August 16, 2018 at 6:37 PM #

      Pam – Depending on how low the fees are and how well the funds give you the asset allocation you want, you may be fine staying with them. But you might want to compare the fees involved in using index funds instead and then weigh the potentially lower costs against the added complexity of managing the portfolio yourself.

  3. Marc August 15, 2018 at 7:15 AM #

    I have some money invested in target date funds with Vanguard. I’ve had those funds for a few years and they’ve done pretty well. I’ve been thinking about moving some of that money for some of the reasons mentioned in this article, but haven’t gotten around to it yet. I do like the convenience of the target funds though. With my daughter’s 529 plan it’s nice to be able to contribute and not have to take time to decide how to allocate the money.

    • Matt Bell August 15, 2018 at 10:12 AM #

      Marc – At least Vanguard’s fees are relatively low. We, too, use the age-based portfolios offered by our 529 plan provider, which work like target-date funds. Unfortunately, there aren’t many other options within 529 plans. While our provider does have some other investment choices, IRS regulations limit to two the number of times per year you can make investment changes, so these plans don’t really lend themselves to following the types of strategies I would prefer.

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