Target Date Retirement Funds

[Lando]

I have an IRA that I don't anticipate adding anything significant to over the coming years, so I've been tossing around the idea of taking it away from our financial advisor and simply moving it to a self-managed Vanguard, Schwab, Fidelity, etc. account to reduce the fees we are currently being charged.

If my calculations are correct, a 1% reduction in fees would translate to a six-figure savings over the next 20 years...and that doesn't even factor in the value of the account rising over those 20 years.

Does anyone have pros/cons/recommendations of simply putting the money in a target retirement date fund vs. picking some ETF's or other mutual funds vs. leaving it with our current financial advisor? I'm busy enough with work and home life so don't see myself actively researching, monitoring and re-balancing accounts on my own.

 

[Hang 4]

Just my opinion, but Target Date funds stink. You're right to look for a reduction in fees, but not sure target date funds really accomplish that. Vanguard index funds are basically free these days. I've had 5 in my 401K for the last 30 years and basically never touched them and have done very well, including when the market wobbled in 2007 and 08. Over that time period, it was hard to lose money, but some managed funds, managed to do it.

 

[Half Fast]

The target date funds in my 401k have had ****-poor performance. If you're looking at a 20-year horizon, just drop it into a S&P 500 index fund and leave it alone.

 

[Eldorado]

Go for it, you’ll be far ahead. Automatic rebalancing, spreading the risk, why pay for something that fails 80% of the time after 5 yrs. I’ve taken a hit over the last 2 mos, why add to it by paying an advisory fee monthly whether you make or lose money. No one has a crystal ball, just ask yourself how much risk you are willing to take. Any time I need advice, I pay for it directly by someone whose advice I value, not indirectly by someone I know nothing about. I’ve used vanguard for 35 years, love the structure of no brokers, no stockholders to pay, little advertising, second largest manager of money in US. Most give them credit for lowering brokerage fees, transaction fees, and expense ratios. There’re many good no load funds around, but no more ethical company in my opinion.

 

[weilke]

I may be mistaken, but most if not all of the Vanguard target funds are unmanaged index funds. They just have a mechanism that moves most of the principal from equity index funds to fixed income/bonds in the last few years prior to the 'target'.

 

[TCABM]

A tale of two funds

VFIFX - Vanguard Target Date 2050
VFINX - Vanguard S&P500 Index

 

[CJones]

I'll jump in on the 'target date funds stink' camp. The first job that I had that had a 401k, I thought "Oh this is easy! Just throw it in that target date and it automagically handles itself!" After a year I went back and compared various funds available to me and the target funds consistently under performed against EVERYTHING else. Since then I spread things out across mid-cap, large-gap, some index funds, and some bonds-based funds and they consistently outperform the target date funds.

I've thought about moving over to a managed account as I have a trustworthy friend that works for one of the big broker shops, but I just can't see what kind of info they could give me that I don't already have - especially when selecting mutual funds rather that individual stocks - that would warrant paying them a scheduled fee.

 

[rtk11]

Sigh, my 401K is in target date funds and it absolutely stinks. Minimal growth when times are good, and... well, based on today's numbers, I'm not retiring until about 30 years after I'm dead.

 

[Dave Theisen]

Everyone’s target date got pushed back five years a month ago.

 

[Half Fast]

Everyone’s target date got pushed back five years a month ago.

Not if you bailed in late February!

 

[airdale]

Wow. Basics:

A target date fund has an allocation to equities and an allocation to fixed income. The allocation changes as the fund approaches its target date, with the fixed income portion increasing.

The majority of the fund's long-term performance is driven by the equity portion. That portion might be invested in an active ("stock picker") fund. Stock pickers typically underperform index funds over longer (5-10 year) periods. Whether that portion is contained inside a target date or blended fund or whether it is held separately the performance is the same. If buying a blended fund, the equity tranche should be a total market index fund of some sort.

@TCABM's graphs demonstrate a firm grasp of reality. Over longer periods, 100% equities (VFINX) are expected to outperform a portfolio that is not 100% equities, regardless of whether that portfolio is held as a target date fund, a blended fund, or comprises individual holdings. IOW, "target date" has nothing to do with it.

If you have a target date fund that "stinks" it may be because its stock pickers are underperforming. Otherwise, saying that it "stinks" simply means you don't understand the investment.

OP is right that paying a big advisor fee is a terrible drain on a portfolio. Personally I will not buy blended funds/target date funds because mixing the red Kool-Aid and the green Kool-Aid leaves me not knowing what caused the color. For a good discussion of simple, reliable, investing options read the "New to Investing" material at bogleheads.org and consider buying "The Bogleheads Guide to Investing" by Larimore et al. An even better book is "The Coffeehouse Investor" by Bill Schultheis. Successful investing is boring. If you're not bored, you're doing it wrong. We look at our portfolio seriously once a year.

 

[TCABM]

Continuing on [mention]airdale [/mention] ‘s post above, here’s a specific breakdown of VFIFX. There’s not a whole lot of diversification, despite being composed of total market funds.

Every few years, the stock fund percentages will be reduced, and the bond fund percentages will increase until its weighted about 65% in bonds. With this fund, it’s pretty easy to look at the underlying assets to see what their performance over time looks like.

It’s not a total dog, and it makes up the majority of the fund today. But the next largest allocation, a little over 1/3rd, isn’t so hot.

The bond side looks remarkably like the above returns.

Over time, as the index stock funds dwindle down as a portion of the allocation, it will become harder for the Total Stock Market Index fund the carry the water of the others, so to speak.

Compare that to VFINX, the S&P500 index funds. Over the next 30 years to 2050, that ~2% difference in performance can make a lot of difference for an account that isn’t going to get any new capital added. Which makes me wonder if that account could be rolled over into an existing IRA.

Source: https://investor.vanguard.com/mutual-funds/profile/VFIFX

 

[Crashnburn]

Vanguard has some balanced, but not target date funds. The problem is, you pay a management fee for the balanced fund, and then management fees for the funds that make up the balanced fund. IOW, it's a double whammy.

They have a balanced index fund. It has both equities and bonds, held directly, so no double whammy. When equities under perform bonds, they load up on equities, and when bonds underperform equities, they load up on bonds. So, they are buying low and selling high. This can add a few % to your yearly return.

I've been investing in VBIAX for going on two years and probably will continue to do so until we sell our house. That's actually just a small part of my investments, though.

For the rest of my portfolio, I only look at it when I have new money to add. Currently, about once a month.

 

[3393RP]

If you're under 40, buy the S&P 500 ETF, symbol SPY, and the NASDAQ 100 ETF, symbol QQQ. Buy additional shares if you happen to remember. Go to sleep for 30 years.

Fees are about $20 per $10,000 invested. A stock picker charging 1% is never going to beat that.

If someday in the future bonds come back from the dead, you might consider that.

 

[sourdough44]

Start with comparing the ‘target date’ fund with your current setup with the advisor, could be better. Moving to Vanguard would be a great step no matter what.

Yes, an easy answer, with a good many years to go is the S&P 500 index or the ‘Total Stock Market’ index fund. It’s all the better if everything is IRA or some other type of retirement $$.

There has always been the spectrum of stock fund types, simple index funds, aggressive managed funds, sector, precious metals, or less volatile choices. For many/most the majority in an index fund is a great place to be.

 

[airdale]

@TCABM, good post. A couple of comments:

1) VFIFX is about as diversified as it gets. The US total market fund holds the 3600 or so stocks listed in the US. The international total market fund holds the 2800 (IIRC) or so stocks listed outside the US.

2) Don't worry about the international equity component. Investing is a long term game and over the long term there are sectors that wax and sectors that wane. Last decade the US large caps did well. The decade before it was the internationals. We hold VTWAX, basically all of the 7400 listed stocks in the world/no home country bias, and we are quite comfortable with that. We're not betting on any sector; we just hold them all. That said, there are a number of reasons to be optimistic about internationals over the next decade: the near-certain rise of China, regression to the mean, and a likely decline in the value of the US dollar being the most prominent. Here is a brief but quite good video on home country bias: https://famafrench.dimensional.com/videos/home-bias.aspx

General:

The essential characteristic of any blended fund, whether a fixed blend or a variable blend like a target date fund, is to trade reduced volatility for maximum total return. Until someone is about 5 years from retirement, I think that is A Very Bad Trade. History says that holding 100% equities will produce the maximum return. @TCABM's VFINX graph tells the tale. But 100% equities can be too wild a ride for some people, hence the market for blended funds and blended portfolios.

Amen on index funds but beware the hucksters who have added "index" to their repertoire of bad investments. The words preceding "index" should be "total market" then either "US," "international," or "global." There is well over a half century of research and data that supports this and it is the reason that estimates say that over half the total stock market is now held by passive investors aka "index investors." Passive investing doesn't put the Porsches and Benzes in the garages of the investment industry though, so don't expect them to explain the strategy to you.

Incidentally, the S&P 500 (SPY, etc.) is not a total market fund. It holds only 15% of the stocks listed in the US. These stocks comprise about 80% of the US market capitalization, though, so advocates of an S&P 500 strategy can rightfully claim that it behaves almost like a total market fund. My view is to eliminate the "almost" part and just buy the total market.

HTH

 

[Crashnburn]

@TCABM, good post. A couple of comments:

1) VFIFX is about as diversified as it gets. The US total market fund holds the 3600 or so stocks listed in the US. The international total market fund holds the 2800 (IIRC) or so stocks listed outside the US.

2) Don't worry about the international equity component. Investing is a long term game and over the long term there are sectors that wax and sectors that wane. Last decade the US large caps did well. The decade before it was the internationals. We hold VTWAX, basically all of the 7400 listed stocks in the world/no home country bias, and we are quite comfortable with that. We're not betting on any sector; we just hold them all. That said, there are a number of reasons to be optimistic about internationals over the next decade: the near-certain rise of China, regression to the mean, and a likely decline in the value of the US dollar being the most prominent. Here is a brief but quite good video on home country bias: https://famafrench.dimensional.com/videos/home-bias.aspx

General:

The essential characteristic of any blended fund, whether a fixed blend or a variable blend like a target date fund, is to trade reduced volatility for maximum total return. Until someone is about 5 years from retirement, I think that is A Very Bad Trade. History says that holding 100% equities will produce the maximum return. @TCABM's VFINX graph tells the tale. But 100% equities can be too wild a ride for some people, hence the market for blended funds and blended portfolios.

Amen on index funds but beware the hucksters who have added "index" to their repertoire of bad investments. The words preceding "index" should be "total market" then either "US," "international," or "global." There is well over a half century of research and data that supports this and it is the reason that estimates say that over half the total stock market is now held by passive investors aka "index investors." Passive investing doesn't put the Porsches and Benzes in the garages of the investment industry though, so don't expect them to explain the strategy to you.

Incidentally, the S&P 500 (SPY, etc.) is not a total market fund. It holds only 15% of the stocks listed in the US. These stocks comprise about 80% of the US market capitalization, though, so advocates of an S&P 500 strategy can rightfully claim that it behaves almost like a total market fund. My view is to eliminate the "almost" part and just buy the total market.

HTH

Actually, Modern Portfolio Theory says you can reduce volatility while increasing yield. The theory says that you have a target
percentage weight for each of your funds. Each fund represents a different asset class. As a fund exceeds that weight you sell the excess, and as it loses weight below it's target, you buy more; as prices of asset classes run in cycles, you'll be buying cheap shares and selling expensive shares. Fixed income funds reduce volatility, provide additional money to invest, and generally go up during market declines, so you can sell your excess fixed income shares, and buy more equities at depressed prices.

That's the theory. In practice, the longer you wait to rebalance, the better your return, and in the limit, never rebalancing produces the best return, at the cost of increasing volatility. I never rebalance; I just put new money into the funds I own that had the worst 30 day trailing returns, and that are below target weight.

 

[airdale]

That's not MPT, actually. That is pretty traditional gospel for establishing and maintaining an AA (asset allocation). It's a popular and effective technique. I have never seen any claims for rebalancing reducing volatility except to the extent that the fixed asset portion does so. Lots of places to read about it. I was just re-reading William Bernstein's "The Investor's Manifesto." He deals with managing an AA there.

Markowitz's big idea in MPT was to use weakly correlated and uncorrelated assets together to reduce portfolio volatility. This lead him to the "Efficient Frontier" portfolio model where picking a level of volatility will lead you to a portfolio mix that maximized total return for that volatility level. The math is very nice, but it has one little problem: For it to work you need to have accurate predictions of future return and volatility.

To me, the idea that volatility is risk seems illogical. During the accumulation phase, volatility is actually your friend because dollar cost averaging buys you more shares. In retirement, volatility is risky for people who have to sell volatile assets to live on. The solution there is an asset allocation that minimizes the chances of that happening. "Sequence of Returns Risk" SORR.

One caution: Basing investment decisions on 30 day returns is IMO just basing them on noise. Something like one-year returns or longer is better. We look at our asset allocation once a year.

 

[Lando]

Great feedback, everyone. I really appreciate it! Reading all of this and doing some research based on the input has definitely given me confidence to take this on myself...while still being able to keep it really simple and manageable. It looks like the trickiest part is going to be liquidating some mutual funds we currently hold that can't be transferred to Vanguard. With the wild swings in the market right now, I would hate to end up selling on a low day and have the market spike over the week I wait for everything to flow from one account to the next. Although, if the market takes a dive in that same timeframe it could actually work out quite well!

 

[airdale]

Are you committed to VG? Nothing bad abut them but you may be able to transfer in kind to Schwab or Fido. Depending on your location one or both of them may have local offices. That is not a big deal but I do see my Schwab guy every year or two. I am not just a voice on the phone to him.

Gratuitous Nag: Don't forget to buy and read "The Coffeehouse Investor"

 

[Crashnburn]

That's not MPT, actually. That is pretty traditional gospel for establishing and maintaining an AA (asset allocation). It's a popular and effective technique. I have never seen any claims for rebalancing reducing volatility except to the extent that the fixed asset portion does so. Lots of places to read about it. I was just re-reading William Bernstein's "The Investor's Manifesto." He deals with managing an AA there.

Markowitz's big idea in MPT was to use weakly correlated and uncorrelated assets together to reduce portfolio volatility. This lead him to the "Efficient Frontier" portfolio model where picking a level of volatility will lead you to a portfolio mix that maximized total return for that volatility level. The math is very nice, but it has one little problem: For it to work you need to have accurate predictions of future return and volatility.

To me, the idea that volatility is risk seems illogical. During the accumulation phase, volatility is actually your friend because dollar cost averaging buys you more shares. In retirement, volatility is risky for people who have to sell volatile assets to live on. The solution there is an asset allocation that minimizes the chances of that happening. "Sequence of Returns Risk" SORR.

One caution: Basing investment decisions on 30 day returns is IMO just basing them on noise. Something like one-year returns or longer is better. We look at our asset allocation once a year.

It might look like noise but you’d be amazed at how often the funds I try to buy start back up almost immediately.

I didn’t mention correlation but I spent many hours choosing weakly correlated funds for my portfolio.

If you have a priori knowledge of fund performance, you wouldn’t bother with any but the fund with the best performance.
The best you can do is choose funds from Uncorrelated or weakly correlated asset classes. For instance because transportation is dependent on energy, you’d expect transportation and energy prices would usually move in opposite directions.