Target Date Funds – Better Off Doing It Yourself?

by Darwin on March 12, 2011

A few years back, Target Date Funds were all the rage as a one-stop retirement account panacea.  After the market collapse of 2008-2009 took many of these “safe” investments down with everything else, people started questioning whether they were really doing the job as advertised.  Since you were trading off aggressive investments and higher returns for less volatility and downside protection with a higher management fee, you’d like to think when the market crashes, you’re protected.  But you weren’t.  Many target date funds had double digit losses, even over 30%, with the high fees to boot.  This begs the question as to whether retail investors and workers were duped.


Are You Getting What You Paid For?

Based on a recent article in the Wall Street Journal, you can see a massive divergence in annual expense ratios.  As usual, Vanguard’s fund is the least expensive.  But check out some of the more expensive funds, at 1.5% and more. That means you could be paying 9 times what someone in the Vanguard fund is.  That’s completely outrageous.  Very few employees have access to more than a single fund company offering a Target Date Fund, if at all.  So, you’re pretty much stuck with what you get.  And given how small the returns are in the later years when you end up in the more conservative mix, eating up a 4% annualized return with a 1.5% expense ratio is pretty much losing money to inflation.  that’s surely not going to get you to “Your Number“.  What’s the point?


Do It Yourself Target Date Fund?

I can say from personal experience, our plan at work has both medium priced Target Date Funds and very low-priced index funds.  While I’m young, I have a very aggressive mix of primarily US equities and International equities.  However, as I get older, I want to have less exposure to equities since they’re the most volatile conventional asset class (Here’s What Happens When You Have Too Much Equities Exposure Near Retirement).  Aside from lower volatility, bonds and commodities offer differing correlation of asset classes, which in essence, means that while one investment zigs, the other zags; or perhaps doesn’t zig just as badly.  So, when the time comes to diversify, and while others are paying higher fees in Target Date funds, I’ll simply be looking at what the purported magic mix is and mimicking it myself with the lowest fee index options I can get my hands on.

Don’t despair if your 401(k) or equivalent employer plan doesn’t offer a particular asset class anyway.  You could always get diversification through a self-directed IRA anyway.  No affiliation here, but I always endorse Vanguard funds since they tend to have the lowest fees in the industry, they’re highly ethical, no gimmicks and have a very high level of customer service.

So there you have it.  I’ve never held a Target Date Fund, and if I can help it, I never will.


What Are Your Thoughts on Target Date Funds?

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1 Roger Wohlner March 13, 2011 at 9:36 am

Good post, you raise some excellent points. I advise individuals, 401(k) participants, and 401(k) plan sponsors. I am not a fan of TDFs generally, I think as you said, many are too expensive. Additionally several seem like a dumping ground for funds which are not as popular on a stand alone basis as the fund company would like. Lastly the communications to plan participants could stand much improvement in general. Often these funds are misused and misunderstood.

2 Chad March 13, 2011 at 7:49 pm

I agree that target date funds are an oversimplified and often overpriced investment option.

Since many defined contribution plans use target date funds as “qualified default investment alternatives”, my cynical view is that there is built-in incentive for the managers of these funds to charge high fees and to use the funds as a dumping ground. The fund companies know that many investors end up in these funds out of apathy, so they can get away with less investor friendly practices.

3 Evan March 13, 2011 at 7:52 pm

I am not a huge fan of target date because it doesn’t really capture someone’s true risk tolerance just a predetermine notion of what someone should be doing. While I am 29 but I am not a particularly risky guy what if that fund said I should have 92% stocks? or if I am a super risk taking 62 year old?

So while I am not a big fan I guess they work for those that don’t particularly pay attention to this aspect of their life.

4 Jon | Free Money Wisdom March 16, 2011 at 10:44 pm

I happen to love my Target retirement fund (2050) with Vanguard. The main reason I have it is because I started investing in college and have been maxing out my Roth in it ever since. I love the simplicity of the fund. And it re-balances my stock/bond ratio as I get older. Since I lean more conservative, this is great for me. I have a feeling though, that down the road, I’ll sell my target retirement fund and split my savings into my own funds that I pick. But for now, it has served me well!

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