Wealth

The ‘one-stop shop’ way for retirement savers to build wealth, according to a financial analyst

When it comes time to make dinner after a long day of work, which kind of cook are you?

Maybe you crack open a bottle of pinot noir along with your copy of “Salt, Fat, Acid, Heat,” sort through your array of fresh ingredients from the local farmer’s market, and whip up a delicious and balanced meal.

More from Grow:
How to earn passive income via affiliate marketing
What motivates this travel nurse who earns $7,000 a month in Hawaii
I quit my 9-to-5 to grow my side hustle: How I got my finances ready

Or maybe you throw everything in your Instant Pot, press a button, and relax until dinner’s ready.

The latter route is perfectly valid. Not everyone has the time, skill, and mental energy to make elaborate meals on a daily basis, especially when so many other things in your life require your focus. The same rules apply to investing for retirement. If you don’t have the wherewithal to set up, monitor, and manage your portfolio between now and your golden years, it could make sense to opt for a target-date mutual fund, essentially the Instant Pot of retirement investing.

“Target-date funds are appropriate for investors who don’t have the interest or desire to dig deep into making decisions regarding retirement savings,” says Joe Guerin, director of investment research at Johnson Financial Group. “They’re really a one-stop shop. Investors have to make two decisions: When do you want to retire, and how much do you want to save? Everything else is taken care of for you.”

Video by Helen Zhao

What are target-date funds?

Target-date date funds are so-called “funds of funds.” They hold shares in other mutual funds to create a diversified portfolio — typically a mix of stocks and bonds. The “target date” in question nearly always appears in the name of the fund (e.g. Vanguard Target Retirement 2050) and is meant to roughly correspond with the year that investors in the fund hope to retire.

The fund grows more conservative as the target-date draws near, shifting its mix from one more heavily weighted toward stocks, to one that slants toward bonds. That shift, called a fund’s “glide path,” mirrors the way financial professionals recommend investors shift their asset allocations over time — focusing on accumulating wealth in their early years and on preserving it as they near the time when they’ll need to withdraw the money. 

“Participants should think of these as an all-in-one investment portfolio,” says Bob Janson, senior vice president of wealth management at Alera Investment Advisors. “They’re designed to be properly allocated, well diversified, and disciplined during bouts of market volatility. They rebalance regularly and reduce risk over time.”

Video by Courtney Stith

How to hold target-date funds in your portfolio

Target-date funds are massively popular. Some 40 million Americans have at least some of their money wrapped up in a target-date fund, for a total of $1.6 trillion in assets, according to Morningstar. That’s up from $1.1 trillion at the bottom of the Covid-fueled bear market and $740 billion investors held in such funds five years ago.

If you’ve come across these investments before, you’ve likely seen them on the roster of funds offered as part of your workplace retirement plan. In fact, such a fund may be the default landing zone for your money if you haven’t selected any investments, points out Grant Edmunds, a certified financial planner at Moneta Group. “Previously, you’d have to opt into investments, and your money would go into a money market as the default,” he says. “Now, for many plans, these kinds of investment options are the default.”

Whether you chose a target-date fund or were defaulted into one, experts say it’s important to understand that these funds are designed to be the only ones in your retirement portfolio. “If you’re using this fund as a core holding and investing in other funds, you’re defeating the purpose of a target-date fund,” says Guerin. “For the vast majority of people who hold these funds, this should be your only holding.”

For the vast majority of people who hold these funds, this should be your only holding.

Joe Guerin

Director of investment research, Johnson Financial Group

That’s because investing in other funds alongside your target-date fund negates the fund’s purpose, which is to manage your investment risks over time. Adding stock funds on top of your target-date fund, for instance, will increase the volatility of your portfolio as you age, potentially leading to larger pullbacks in your portfolio than your finances can handle.

That isn’t to say that you might not boost your returns by adding on some extra funds. And the mutual fund police aren’t coming to arrest you if you use these as part of a bigger portfolio. But if you want to be hands-on with your investments, maybe target-date funds aren’t for you in the first place, says Janson. “When you deviate from the target-date strategy, you basically say, ‘What I feel is right is more appropriate for my retirement savings than what the professional money manager I’m paying is doing.'”

How to choose the right target-date fund for you

No two target-date strategies are built exactly alike. If you’re looking to hold one in your 401(k), you likely won’t have a choice to make — your plan will often hold one family of funds. But if you’re looking to add a target-date fund to an individual account, such as a traditional or Roth IRA, experts say you’d be wise to ask yourself three questions before buying one.

1. How much does it cost?

One drawback of getting someone else to manage your portfolio for you: You have to pay for it. At the end of 2020, the average expense ratio among target-date funds was 0.52%, according to Morningstar — well above the miniscule expense ratios you can pay for a portfolio of broadly diversified index ETFs.

Some target-date funds hold a portfolio of index funds. Those will typically be cheaper than funds that hold a mix of actively managed funds. When it comes to what you pay, consider whether you think active management will deliver outperformance over a mix of indexes, says Janson. “People tend to just focus on expenses, but there is a reason why some funds are more expensive than others. It’s not just because the fund family is greedy,” he says. “If you don’t think an active manager can outperform, that’s an important consideration.”

Be especially wary of funds that “double-dip” by charging an expense ratio on top of the fees for the portfolio’s underlying funds, says Edmunds. “If that’s the case, you’re better off building your own allocation.”

2. What is the glide path?

While virtually every target-date fund will start you out with a high percentage of stocks and end things with a high allocation to bonds, each fund has a unique glide path. “Some funds are going to be fairly aggressive throughout their glide path, which will give you a more volatile path along the way. Some are going to be more conservative,” says Guerin. “Some of them will have a static asset allocation that begins at the target date. Some funds will continue to adjust through retirement. You need to fully understand a fund’s risk profile and how it aligns with yours.”

You can find a guide to any fund’s glide path, along with a list of the funds it holds, on the fund company’s website.

3. When do I want to retire?

Even if you select a fund that aligns with your risk tolerance early on, continue to monitor how you’re aligned for the rest of your career, says Janson. “The default is to assume that you’re going to retire at age 65, but your retirement date may be further out than that,” he says. “If you think you’re likely going to work until age 75, it may make sense to invest for a longer glide path.”

You may also want to adjust the date further out or closer in if you want to be more or less aggressive with your investments, he says. “We talk to plan participants, and sometimes a 58-year-old wants to invest like a 30-year-old,” he says. “In those instances, you can pick a date that’s further out. The fund will still work wonderfully as a standalone portfolio as long as you’re comfortable with the time horizon.”

The article “The ‘One-Stop Shop’ Way for Retirement Savers to Build Wealth, According to a Financial Analyst”  originally published on Grow (CNBC + Acorns).

Products You May Like

Leave a Reply

Your email address will not be published. Required fields are marked *