Why You Shouldn’t Buy Target Date Funds

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Wanderer

The Wanderer retired from his engineering job at a major Silicon Valley semiconductor company at the age of 33. He now travels the world, seeking out knowledge from other wealthy people, so that he can teach people how to become Financially Independent themselves.
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For some reason lately I’ve been getting a bunch of emails asking me what I think of a particular Target Date Fund, so I thought this would make a good article.

But before we get into what I think of these things (hint: It’s in the title of this article), let’s first talk about what these things are.

What is a Target Date Fund?

Target Date funds are also known as Lifecycle Funds, Age-based Funds, or Dynamic Risk Funds. That last one sounds makes it sound pretty cool, but basically what Target Date funds do is adjust your asset allocation as you get older and closer to retirement.

These funds typically have a year, or “Target Date,” in it’s name. The idea is that based on your age, you pick the fund with the year in which you will turn 65 and just buy that fund. So if you’re 20 right now in the year 2018, you would pick the fund with the Target Date 2018 + (65 – 20) = 2063, since that’s when you’d turn 65.

How the fund operates is that if the Target Date is really far away, the fund shifts most of it’s holdings towards equities. The Retirement Fund 2060 shown above, for example, has an 85% equity / 15% fixed income weighting. Then, over time as your Target Date approaches, the fund gradually rebalances your asset allocation towards fixed income. The Retirement Fund 2015 in that series, meaning this fund is for people who are already 65+, has an asset allocation of 45% equity / 55% fixed income.

So Are They Any Good?

Well, yes and no. Mostly no.

First of all, these things aren’t free. If you look back at that chart above, this particular fund provider charges around a 0.75% fee for running this fund. And as we’ve written before, over time fees can have a pretty massive impact on your portfolio growth. Given that a typical Vanguard Indexed ETF has fees less than 0.1%, you’re paying a pretty high premium on these things, and the only service you’re getting is basically rebalancing your portfolio for you once a year.

Also, it’s easy to catch Target Date fund providers doing sketchy things. You’d figure that once an asset allocation were decided based on age, Target Date funds would just buy Index funds to track each asset type and be done with it.

Nope.

Some of them (actually, most of them from what I can tell) go the additional step of using actively managed funds to build their portfolios. Each of these funds also has a management team, and a marketing team, and compliance people, so these funds also have their own separate fee that’s quietly lumped into your bill. And surprise surprise, if actively managed funds are used, they are always run by the same company that’s running the Target Date fund. After all, they wouldn’t want some other company stealing your money, right?

These things typically charge 1-2% by themselves, so if you add that to the Target Fund’s MER, you’re looking at a total 2-3% fee that’s silently taken out of your account each and every year. You’re employing a team of dozens of people to do a job that a spreadsheet can do.

They’re Trivially Easy To Beat

The funniest thing about Target Date funds is that unlike Hedge funds (which you also shouldn’t buy), Target Date funds are required to tell you exactly what they own. It’s right there on the fund’s summary page or its prospectus.

This is the asset allocation for the Retirement 2060 fund. So, that’s 55% domestic (US) stocks, 30% International stocks, 8% Domestic (US) bonds, 4% International bonds, and 3% cash and other random crap. Right away, I’m thinking 3% cash? What? Why am I paying you to hold cash? But whatever, that’s a separate issue.

So here’s how to beat this fund. Just buy the underlying index ETFs yourself.

ETFs (and mutual funds) exist because it’s usually not practical for an individual investor to buy the underlying stocks themselves. To replicate an ETF tracking the S&P 500, I’d have to actually buy those 500 stocks myself. That’s a lot of work, and would require me to have at least a couple million dollars for it to be even possible (since you can’t buy fractional shares).

But for a Target Date fund? They’re just buying other ETFs. I can easily do that myself.

So for this particular fund, I’d buy the following:

Symbol Description Allocation
VTI Total Stock Market ETF 55%
VEU FTSE All-World ex-US ETF 30%
BND Total Bond Market ETF 8%
BNDX Total International Bond Market ETF 4%
CASH Why The Hell Am I Holding Cash Again? 3%

There. We have just replicated this fund’s asset allocation, and because we aren’t paying the Target Date fund’s 0.75% MER, we can expect my portfolio to beat the Target Date fund’s performance by 0.75% each and every year.

But what about the rebalancing the fund manager does each year, you might ask? You’re going to miss out on that!

Not really. Because the fund is required to update their prospectus each year, all I have to do is keep checking the fund’s website. They’ll tell you what their new asset allocation is, and then you can just rebalance your portfolio to match!

So what we’ve done here is, essentially, taken the hard (?) work of this bank-owned retirement fund, completely stolen it, and have replicated it for free. I have just robbed this bank, and completely gotten away with it!

Me, but, you know, legal. Photo by Henry Burrows @ Flickr.

Never pass up an opportunity to legally steal shit from Wall Street. Never.

Is There Anyone Who Should Buy It?

The only people who should buy one of these things are people who, for whatever reason, have to pay a really high transaction fee for each buy. Because buying this fund only requires one transaction rather than 4, theoretically that could save you money, but I’d argue these people should instead open up accounts at either Questrade or Vanguard, which allow free ETF purchases.

The only other time it makes sense to own one of these is if you have a really low amount to invest (like less than $100) and you can’t effectively replicate their asset allocation because you can’t buy fractional shares of ETFs. Though in that case, I’d say just wait a little longer until you have more money. Or buy the Target Date fund temporarily, and when you have more then jump out and replicate yourself.

But the real target audience of these funds are Convenience Shoppers. Just buy this fund, the banks say! It’s a one-stop solution for all your investment needs! And then you don’t have to think about it anymore!

I have another name for Convenience Shoppers: Incredibly Stupid and Lazy People. The difference in work is clicking 4 times once a year instead of clicking once. They’ve already done all the work for you! Just steal it! Steal their work!

But I guess if you’re Too Stupid and Lazy and just want the banks to take your money, then I guess these things make sense for you. Though I would argue if you’re that Stupid and Lazy, you probably don’t deserve to become FI.

So that’s my take on Target Date funds. I suspect I won’t be getting many advertising offers from them any time soon, but who gives a shit. We’re here to tell the truth, not make money that we don’t need.

What do you guys/gals think? Can you think of a scenario in which Target Date funds makes sense? Or are they just for Stupid and Lazy People? Let’s hear it in the comments!



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39 thoughts on “Why You Shouldn’t Buy Target Date Funds”

  1. Cool article. I’ve been pondering moving my target date funds into index funds. When I first started experimenting with being a DIY investor 3 years ago, I felt nervous about screwing up my retirement portfolio, so I made the decision to invest my retirement money into target date funds through vanguard. I ran the fees on each Vanguard fund, and they were relatively inconsequential. (.05% for VTSAX and .16% for Vanguard target date funds)(It’s only a $10 annual difference on a $10K investment) But 4 years later, I am starting to feel like a more confident investor, and now that our retirement accounts are climbing above the $50,000 mark, those fees are starting to get larger. So in the next year, I think I am going to start going all equities in my retirement accounts, (as I have a cash-flowing real-estate business to anchor my portfolio) or learn what ratio of stocks to bonds I prefer in my retirement accounts. In either case, vanguards inexpensive target date funds were helpful for me in the beginning, as they gave me confidence that I couldn’t screw my retirement account up on my own. But now that I am an inexperienced investor, I am looking forward to dropping some of the fees, and manage my ratio of bonds/equities in my retirement accounts on my own.

  2. My workplace DC Pension Plan has about 30 funds to choose from and I use the target date fund with a .5% management fee. The plans are managed by a company that charges ridiculously high fees to individual clients.

    PS did you ever get an update from that guy with the condo in Edmonton?

    1. Yeah OK, I guess there is a 2nd reason to use these, and that’s if there are literally no better options. But still, are the TRFs using funds you also have access to?

  3. My wife’s retirement plan has target date funds and they are pretty good. Low fees and simple. I think it’s good for people who don’t know much about investing (or care.) It is working very well for her. She’s lucky that their target date funds are pretty good.

  4. I don’t like Target Date funds, but I recognize most people are stupid and lazy. And the ones from Vanguard are low cost. Most stupid and lazy people will do better in a Target Date fund than they would picking their own funds. That’s pathetic, but it is the truth. So I often advise people to opt for the Vanguard Target Date funds in our retirement plans if I see their eyes glaze over when I talk about the mutual funds in our plan. Most people find this stuff incredibly tedious/boring/difficult. A lot of it is in their heads, but it’s tough to change those perceptions.

    Granted, your readers are more proactive than the typical stupid/lazy person out there, so I expect better of them. But unfortunately, Millennial Revolution readers are a small slice of the population.

    1. Again, if they’re too lazy to read a prospectus and copy their moves, they don’t deserve to be FI.

      You have to earn your right to be part of this community. You can’t just show up and expect someone to do all your work for you.

      1. I was talking more about the general populace rather than the FI community. At the same time, the thing that matters more is your savings rate, as I’m sure you know. A high savings rate of 50% or more of after tax income makes up for investing in below average funds. Not that I’m recommending that, but it’s definitely the more important factor.

  5. Not really a fair comparison. Why not compare Vanguard Target Date funds to Vanguard funds? There’s no .75 fee on those. Alternatively, you could compare Vanguard Target Date Funds with putting together your own actively managed funds through whatever that company is that you’re using for your straw-man example. Comparing a high fee target-date fund to a low fee set of index funds is stacking the deck.

    And no, people who use Vanguard Target Date Funds aren’t lazy or stupid. They are willing to make the monetary trade-off for not rebalancing, which last time I checked wasn’t that big of a mark-up. I think even the cost for Fidelity target-date funds has gone down since last I checked. The perfect is the enemy of the good and investing in low cost Target Date Funds (such as those from Vanguard) is one of the recommendations that economists who study retirement savings have for the bulk of people with 401k. Set and forget. There’s no temptation to sell when the market is low. There’s no worry about rebalancing too much or too little or not at all because it’s hard to figure out what % to have in stocks and bonds so people put it off. No time has to be taken off to sit down and figure out what the numbers are. It’s a great solution for people with busy lives who have better things to do with their time but don’t want to pay for a professional. (Waaay less expensive than a professional.)

    1. Nope. It’s a rip off. This is how I look at it. I work hard for my money. I want it to grow in the most efficient way possible. When I look at 0.75%, I don’t see a percentage. I see dollar signs. That’s why the scam works because people only see an intangible percentage. On $1,028,000, that equates to $7,710. Therefore, for 30 minutes worth of work each year rebalancing my portfolio, am I willing to hand over $7,710? You already know what my answer is to that. Even if the average MER is 0.20% for a basket of ETFs, that still leaves 0.55% of ripoff or $5,654. That equals my not being able to spend $15.49 a day every day of the year on me. That’s a served lunch every day. Every Day! Lunch or unnecessary fees? Lunch please.

      Everyone has a different balance and so the fee comes to a different dollar amount. Regardless, it’s money thrown willingly in the garbage. That’s why most most people don’t get ahead and only a few do.

    2. Hey that’s the average MER of TRFs out there, but that being said yeah the Vanguard ones ain’t bad I gotta say. Still not worth it to save 10 minutes of work a year but whatever.

  6. Hey thanks… I just wrote how I tell folks that don’t know anything about investing to put their money in target date funds… Ass!!

    But, yes, I think you’re right for people that care and people that understand. On the other hand, for folks that have no idea and don’t care, I think it makes sense for them to throw money in there, and then worry about it later. And at .15% for a vanguard target date fund… It’s not the worst in the world, then if they never touch it again, they’ll be ok.

    That comes with the caveat that they wouldn’t be investing otherwise, and they absolutely don’t want to bother with it at all. Until later when they can make proper adjustments.

  7. I have a Blackrock Lifepath Retirement Fund in my 457 account and only pay .06 % fees. Not bad. Also, if I die my spouse, who isn’t interested in investments doesn’t have to do anything. … I feel and think for most people in our situation this is good enough. One size doesn’t fit all. It’s like taking a multi-vitamin, probably good for most people, if not at least not harmful. Read J.L.’s book.

    I enjoy your blog as well as all other F.I.R.E. blogs and consider the information and then take what is useful for me.

    Sometimes us F.I.R.E. People come off a little self-righteous, me included. Just saying.

    1. Oh wow, 0.06%? That’s actually pretty good. Maybe that one’s OK. Surprised some are actually that low. The fund companies I looked at (who shall not be named lest the lawyers come after me) were shite, pure and simple.

  8. I understand your point about the fee, but i’m curious to know if you think that at the same cost, the target date funded strategy is worth it or your just plain better to do 60-40 for your whole life.

  9. Thanks for this great post, Wanderer, it was really helpful. I had my work pension money (not my main investments) on a Target Date Fund and never really looked at the fees and how it was performing until now (maybe lazy applies but not stupid since I just transfered to a more aggressive option!). Fees were 0.4% and are now slightly higher but the more agressive fund has been performing a lot better over the years so I think it’s worth the change. Anyways, without reading the post I wouldn’t have changed anything so thank you!

  10. The fund I have from Vanguard, VTIVX for 2045 only has an expense of 0.15, which is a lot less than 0.75. Where did you find that fund from the post?

  11. I just helped my partner move out of target date fund. We reduced the expense ration by 10x – 0.30% to 0.029$ !

    Only one ETF was available in her 401k, the vtsax. Is this normal? Are the assets allocation mirrored by the tdf’s between the 401k and ira?

  12. Hi Wanderer,
    I agree with you on not buying target date funds. However, we deviate on the rest: I would not advise to replicate target date funds. My reasons:
    1. I would try to keep it simple (Simple Path to Wealth, to quote Mr. Collins)
    2. I would not buy bonds

    So, I think I might have to explain why I would not buy bonds. I wrote a whole post on it, but since it is in German I just give you the gist:
    Bonds go up if the interest rate goes down and vice versa.
    With the interest at an all time low, the fed can only raise the interest.
    But what happens to bonds then? Bonds that I already own will keep the same low interest and the course will drop to accomodate the rising interest.
    That means I am not only loosing money due to inflation, but also due to a rise of interest.
    My conclusion: I would leave my money in cash and not buy new bonds.

    So, why are bonds so popular? Easy, the interest constantly sank for the past few years making bonds a very good ans safe option to invest in. But those times are over now, because the interest is on the rise again…

    1. Long Bonds have suffered with the current increase in interest rates, they always do, but they do serve a purpose. they hedge against a market decline, when, (not if ) another recession hits, interest rates drop, and make bond prices rise.

      Tracking my distributions on both the RBC Can Bond Index, and Short Term Bond fund, both are holding their own, no they are not making a dime, but they have not lost money. So, its the same as holding cash, but can increase with a Market Decline.

      Yes the days of Holding Corporate Bonds is really over, so now a better strategy might be Preferred Shares, and good quality Dividend Consumer staples, as a balance to a full Equity Portfolio.

      I have 2 Nasdaq funds that I want to move into my direct investing account, and will look to purchase some J&J, BRK, or REIT’s.

      cheers

  13. Thanks for the info and breakdown on fees.

    I have an aside query… Have you looked into Bitcoins and virtual currency investments? What are your thoughts?

  14. I have stayed far away from target date funds, choosing either index ETFs or low ER dividend growth ETFs. With the latter at least there is growing dividend income and some quality metrics (“smart beta”) used in selecting dividend stocks, but still they have ER between 0.1-0.3%, far cry from 0.75% that these target date funds charge. Focus on your real target, not the date! 🙂

  15. I basically agree with you. Fees are too high. There is one or two cases where it might make sense. If you have this as an option in a 401K plan and never want to trouble yourself with rebalancing and overall account balance is still so low that the fee differential isn’t a huge cost in terms of actual $.

    If you want to truly outsource this stuff, though, you could go with a Robo Advisor which would probably provide better overall value for the same fees.

    I myself would never do either, but I love this stuff and recognize that the truly intense do-it-yourself investor will always remain a minority.

    On the other hand, ever watched that video the Paradox Of Choice By Barry Schwartz on YouTube? (It’s super funny.) I do wonder if trying to get most people to do all the money management themselves doesn’t border on the edge of overoptimization…..

  16. I find about 1 in 10 people I know, have a clue about investing… they have all their investment in one fund with an insurance company, and think its an investment broker.

    They get their advice from TNLATB, else they tout the fact they are getting a 5% return from a GIC, or something just as stupid. They have no concept of risk/return, nor do they care.

    For these people, its probably a good thing, as it will protect them from stupid mistakes, buying precious metals, and getting conned by get rich quick schemes.

    If I start to see their eyes glaze over when I mention MER, then I back off and tell them to leave it in a Balanced fund, netting 5%, or something like this.

    cheers

  17. Good read. I think Target Date Funds have their place for those that are not disciplined investors. In order to invest on an ongoing regular basis (which you should to take of dollar cost averaging), a person would need to understand their target allocations, take the investment amount and divide it up, and account for the current price of each ETF. Again, not super difficult.

    But for a person who isn’t disciplined or is intimidated by investing, these extra steps then become a hurdle, and then scape-goat, for them to not get into investing. Investing in a Target Date Fund is better than not investing at all in those cases.

  18. Not all people who invest in Target Date Funds are Stupid or Lazy. It boils down to how you’re investing in it, and what you’re getting out of it.

    I invest in Vanguard’s Target Date Fund via my 401(k). It has an expense ratio of 0.15%, which is reasonable: https://investor.vanguard.com/mutual-funds/profile/fees/vfifx

    Out of all other fund options my 401(k) plan offers, this fund has the least expense ratio. I get employer contribution into my 401(k) as well as tax-sheltered income, so not investing in 401(k) is not an option.

    However, I don’t invest my savings in the same Target Date fund. I go with VTSAX for that, because of an even lower expense ratio of 0.04%: https://investor.vanguard.com/mutual-funds/profile/fees/vtsax

  19. You could start by switching your RBC funds from the series A funds to series D. The MER should drop from ~2% to ~1%, depending on the exact fund. The fund will be exactly identical, with the only difference that you no longer qualify for “advice.”

    (If ever you want or need “advice” in the future, you can always switch back to series A at that point. For example, when it comes time to withdraw from the kids’ RESPs, where it can be worth getting help to do so most efficiently.)

    1. thanks Pete, I’ll check it out. I know I am paying way too much in MER, but the Dividend fund seems to be doing much better than a TSX index, so I keep it.

  20. As mentioned by at least one person, the military’s target date funds have an expense ratio of 0.04%. They are too conservative for my taste:

    http://www.militarymillions.com/2018/06/12/are-the-thrift-savings-plan-lifecycle-funds-too-conservative/

    But because of their low cost they are not a bad choice for those who prefer simplicity:

    http://www.militarymillions.com/2018/06/07/tsp-fund-deep-dive-the-lifecycle-funds-hitting-the-easy-button/

  21. They do have higher fees than many alternatives, but it is a great “set it and forget it” option. For those who don’t know or care much about investing their behavior will be a bigger factor than fees. These funds automatically rebalance to the desired asset allocation. That alone may be worth it for many. It also has a mix with bonds. Some investors need those to prevent them from panicking in a crash. On their own they may not know what or how much to pick.
    So in summary, I don’t choose them because I can pick cheaper options and rebalance and (I hope) not panic in a crisis. This doesn’t apply to everyone though.

  22. About two years ago most of my investments were in a Vanguard Target Retirement fund (2025). Then, after reading Jim Collin’s book, I moved all of my funds to VTSAX and VTI. That move resulted in saving me 10 bips on my investments (14 bips – 4 bips).

    In my case, target retirement funds were too conservative. I live a very low-cost frugal lifestyle and I’ll start receiving my pension in 5.5 years, so I can afford to be aggressive. Back when I suffered from analysis paralysis, TR funds were a decent option. But, over time my investment philosophy changed and I left my TR fund.

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