The main benefit of target-date retirement funds is convenience. If you really don’t want to bother with your retirement savings, just check off the box with the fund corresponding to your desired retirement age. The money gradually moves from stocks to safe bonds as you age, presumably letting the money grow in your younger years while securing your nest egg as your retirement date grows near.
Fund Structure
A target-date fund (TDF) is actually a fund filled with other funds, almost always from the same fund company that offers the TDF. For example, a 40-year-old’s TDF would typically contain something along the lines of 40% in a U.S. stock fund, 40% in an international stock fund and 20% in a bond fund. You could buy the exact same three funds individually, but then you’d have to rebalance the portfolio every couple of years as your retirement draws near. By contrast, the TDF is a prepackaged product that rebalances your investments automatically.
Double Fees
As usual, when the finance industry makes something easy and convenient, it means you’re paying a premium. In this case, the TDF charges an annual fee on top of the underlying three funds. So if the three funds in the example above cost 0.5% each, and the TDF charges another 0.5%, you’re getting hit with double fees year after year, which amounts to a sizable bite out of a six-figure nest egg.
By comparison, a meeting with a financial advisor every couple of years only costs a fraction of the extra fund fees. It also has the benefit of providing you with an investment strategy that the advisor tailors specifically to your needs and desires.
Bonds Drag Down Total Returns
As interest rates have dropped in recent years, many experts also question the wisdom of the inclusion of bond funds in TDFs. For young people in particular, with 30+ years to retirement, being automatically steered to 10 to 20% bonds is questionable even with normal rates. With so many years of compounding, the lower return of those 10 to 20% of assets may mean tens of thousands less at retirement age.
Elderly investors who are close to retirement are typically moved to 70 to 80% bonds, which lowers the risk but also the investment return. Experts suggest lowering the risk by diversifying into large-cap stock funds instead, arguing that the dividends paid by large-cap companies exceed bond yields. Meanwhile, spreading the holdings across many stocks in different countries lowers the risk comparably to bond funds. Bond yields are extremely low, and a nest egg placed largely in bonds struggles to keep pace with inflation as long as low interest rates persist.