What are the pros and cons of using target retirement funds and otherwise?
Posted by Dolores
S M asked:
I have heard of target retirement funds, but do they give the best yield and do we still have to re balance the account every few months and manage the account like one would do if it wasn’t a target retirement fund??
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I have heard of target retirement funds, but do they give the best yield and do we still have to re balance the account every few months and manage the account like one would do if it wasn’t a target retirement fund??
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June 27th, 2009 at 3:56 am
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No - the whole concept of target date funds is that they provide an appropriate asset allocation for your time frame that automatically adjusts as time passes.
June 28th, 2009 at 6:00 am
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The main rationale for those funds is that they give you immediate diversification with assets (stocks and bonds, mostly), allocate those assets in a ratio that is set reasonably according to your retirement time frame, and automatically rebalance. The asset ratio is adjusted over time as you get closer to retirement.
They are a one-stop no-further-thought-required solution to investing for retirement. As such, if you put all your retirement money into a target retirement fund and otherwise ignored it until retirement, you’d probably do better than 90% of investors.
The main drawbacks include these:
Some of the target retirement funds are layered with hidden fees — but you can get Vanguard or Fidelity funds that are very low fee.
They usually only include 2 to 4 of the major asset types, so they’re not as well-diversified in that way as you possibly could be — but very few people include as much as 4 or more types of assets in their retirement plans.
Their judgement of the appropriate asset ratio for your age may not be the best one — but it is still probably better than 90% of investors do.
If you are interested in one, pick the year that is closest to your retirement plans, get the prospectus and read it (again, less than 10% of fund investors do!) With careful reading you’ll see if the REAL fees are reasonable (as opposed to the nominal fee), and you can see what assets they are investing in, and the ratio that they are aiming at.
June 28th, 2009 at 2:07 pm
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Best Yield is a term that really should not be used in this context. In the first place yield and return on investment are related but different things. In the second place, a short term focus on highest yield and or return has been proved, unambiguously, to reduce long term investor returns.
Target retirement funds have two underlying concepts: (1) getting the best long term RISK ADJUSTED return from a diversified portfolio of mutual funds and (2) putting the investor (you) in a position of automatically doing the things that (marginally) increase return over the long term (diversify, buy-low/sell-high, etc.)
In layman’s terms the pros of well managed low cost target funds (all target funds are not created equally) are (1) professional diversification and (2) professional re-balancing which should lead to a higher long term return with less risk than an individual could achieve.
The cons are largely irrelevant (or dangerous) for layman. (1) You are locked into market based returns (index funds) and (2) You cannot take advantage of unique buying and selling opportunities as they pop up in the market. These cons are irrelevant because, to take advantage of them in a real brokerage account, an investor must have a devotion to research and analysis and nerves of steal; something very few professional have…let along laymen.