I’ve recently been asked by several friends and family what I thought about target date retirement funds since they are a fairly new investment vehicle.  What are they and should I invest in them?  Is it too good to be true?  Well let’s start off by establishing what a target date retirement fund is.  

A target date retirement fund is a mutual fund.  More specifically, it is a multi-fund portfolio “customized” for your projected retirement date.  Instead of building your own portfolio of stocks, funds, bonds etc, the only decision you make is when want to retire.  The fund is managed appropriately so that it incorporates more aggressive funds (and asset allocation) when you’re younger, and gradually becomes more conservative the closer you get to your retirement date.  Also, once you retire and start relying on those funds to buy red sports cars, bayliner yachts and million dollar mansions, the fund takes that into account and adds more income producing investments.  Since these funds are mutual funds, they are actively managed by “professionals” and incur a cost (usually in the form of the expense ratio, front loads or end loads).  

Vanguard’s target date retirement funds are highly regarded by the investment community so let’s look at one as an example.   Let’s say you’re in your 20’s and you want to retire somewhere around 2050.  

You would put all of your retirement money into VFIFX, Vanguard’s target retirement fund for 2050.  Today, 90% of the fund would be invested in stocks (more aggressive).  In 2030, that fund would comprise of around 80% stocks, a slightly less aggressive approach.  Last, in 2050, that fund will be close to 50% stocks and 50% bonds, an extremely conservative approach.  Seems peachy, right? Well here are the pros and cons of target date retirement funds:

Pros:  

*Bypass minimum investments - Most mutual funds have a minimum investment (usually a few grand) to buy into the fund.  If you try to buy into various funds individually to create a well diversified portfolio, you will need a substantial amount of cash.  For target date retirement funds, you only pay this minimum investment once. 

*Automatic investments - It doesn’t matter how much self control or investment knowledge you have.  You automatically get a desireable asset allocation that shifts with time.  Along with that desired asset allocation comes a certain amount of reassurance that you won’t lose your entire nest egg.
 
Cons: 

*Subpar performance - Investment firms will undoubtedly look out for their own interests.  Therefore, firms like Vanguard or T Rowe Price will only include their companies funds (stock/bond/investment/emerging market) in their target retirement funds.  Therefore, you may lose out on performance.  Surely, that company does not have the best mutual funds in every single market.  

*Lack of control - The selling point of target date retirement funds is that you don’t have to own anything besides it.  But at the same time, you shouldn’t own anything besides it (or you will throw off the asset allocation. That means apart from that one fund, you have zero control in your retirement assets.

*Fees - This is the same argument between mutual funds vs index funds.  Sure you’re paying someone to manage the fund, but can you get the same or better performance from owning the market (index fund)?

Bottom Line:

You have to weigh the pros and cons of target date retirement funds with your investment style and future goals.  If you have no desire to have any control over your retirement assets and are okay paying a small commission for someone else to do it, you may want to consider these funds.  But if you (like me) enjoy having full control of your finances and believe you can make a better play with index funds and virtually no fees, I’d advise you stay away from target date retirement funds.

How do you allocate your retirement finances?  What are your thoughts on target date retirement funds?