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Target Retirement Funds: A One-Decision Portfolio

Target retirement funds are mutual funds that hold a group of other mutual funds run by the same company. They come with names like “Retirement 2040,” which–unsurprisingly–would be used by investors who plan to retire in 2040.

The idea is that target retirement funds automatically adjust their asset allocation toward more conservative investments as the retirement date draws near. They also automatically rebalance the portfolio on a regular basis (usually annually) to ensure that the investor’s asset allocation is appropriate for his or her age.

How to choose a target retirement fund

First, you’ll have to choose which fund company you want to use (unless we’re talking about a 401k in which you don’t have a choice of different fund companies).

I’d suggest looking for a company that uses index funds (as opposed to actively managed funds) to make up their target retirement portfolios. But that’s up to you.

The main consideration should be to make sure that the accompanying expenses are low. Check to make sure that the target retirement fund doesn’t add an additional level of expenses beyond those charged by the underlying funds.

Update: Apparently Morningstar went and did this research for us. The conclusion is that Vanguard’s target retirement funds cost just 0.18% per year, and the next cheapest alternative (Wells Fargo) costs more than three times as much!

After choosing a fund company, simply take a look at the fund with a retirement date closest to when you expect to retire. Then perhaps adjust 5 years either direction if the asset allocation appears too aggressive or conservative for your tastes.

Are they too simple?

In short: No.

It can feel somewhat risky putting your entire account into one fund. Almost like an “all your eggs in one basket” sort of situation. But that’s simply not the case. In reality, you’ll own a handful of funds, each of which holds hundreds–or even thousands–of different investments. You’ll be extremely diversified.

It’s entirely reasonable for an investor to put her entire retirement account into a low-cost target retirement fund that matches her desired asset allocation.

In fact, if you’re convinced as to the advantages of indexing, there’s hardly any reason why you wouldn’t want to use a target retirement fund. They add no costs, and they take care of rebalancing for you. What’s not to love?

Some people, however, will argue that target retirement funds are simply too boring. I’ve never much understood that viewpoint.

To me, retirement investing is not a game. This is your future livelihood we’re talking about here. The point of investing isn’t for it to be fun or exciting.

In summary

If you’re looking for a portfolio/investment strategy that’s:

  • easy-to-understand,
  • easy-to-implement, and
  • low-maintenance

…a low-cost target retirement fund is very hard to beat.

Not-to-be-overlooked bonus: Your investment results are likely to be significantly better than they would be if you were picking stocks or trying to find this year’s hot fund.

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  1. The heart of a Target Retirement Fund idea is that you should have more debt when you are young and less debt as you keep getting older. So really, not only do you need to invest all your money in one particular fund, you need to keep doing that throughout your life or at least for a very long time. I don’t see this as a practical thing at all.

  2. Hi Manshu.

    I think you have it backwards. Target retirement funds own less debt investments (bonds) when you’re young, and more when you’re old.

    In other words, they adjust from a more aggressive allocation toward a less aggressive allocation as the investor gets older.

    Also, what’s wrong with investing in a fund for your entire lifetime if it’s a good fund? (For example, what would be wrong with investing for several decades in a low-cost index fund that tracks the Wilshire 5000?)

  3. Yes Mike, you are right, I am sorry that I got that backwards. I just question whether it is practical to buy just one fund for your whole life with all your money.

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