Why Target-Date Funds Are the Worst Thing You Could Invest In for Retirement

retirement financial planning

Investors are always looking for the next great product that can help them gain an edge on the market. From the dissatisfaction of the performance and fees of mutual funds, came the advent of ETFs. But investors still wanted a total investment vehicle that could be used in retirement accounts that didn’t need yearly adjustments or modifications. They wanted something that could be invested in and never touched again.

In response, the investment industry came up with the target-date retirement fund. A fund that automatically sets up an allocation between stocks and bonds and slowly changes that allocation over time to become more conservative. To some investors, it’s a one-stop-shopping option for retirement, making it easier to participate in programs like a 401k or IRA, but the drawbacks of such a plan might not be worth the ease of investing.

Automation in your investments may not be all it’s cracked up to be.

It’s seems like a good idea to create an all-in-one retirement fund that any investor can participate in and not have to think about until they actually retire. But unfortunately, there’s a number of incorrect assumptions that target-date-retirement funds hold.

The first problem is the lack of allocation options. Unless you’re an investor whose risk profile perfectly matches a target-date-retirement fund, you’ll either be over exposed to risk, or more commonly, under-exposed.

What’s the issue?

The way these funds allocate depends on the target date of the fund. If you have 20 years until retirement, you would choose a fund with a target date of around 2035. As you get closer to that date, the fund automatically adjusts your stock and bond allocation to be more conservative without you having to do anything on your part. The problem is that these funds are really just broad attempts at filling the needs of multiple investors without considering individual specific needs or goals. One fund cannot possible fit the needs of every investor who intends to retire within that time-frame.

The other issue with target date retirement funds is the same issue that’s plaguing the mutual fund industry – fees. The average fee for a target date fund is around 0.45 percent. That doesn’t sound like much, but compounded over several decades, it becomes a more significant loss. An 8 percent gain over thirty years at $1,200 a year comes out to be around $136,000. Taking away 0.45 percent changes that final amount to $125,000 – a loss of $11,000.

For the conservative investor who may not have the time or ability to manage their retirement portfolio, a target date fund could work. The biggest mistake investors tend to make is assuming that a target date fund means that no other investments are needed. Diversification is still an essential part of any retirement plan. If a target date fund is chosen, that doesn’t mean other types of investments aren’t needed.