In this week’s episode the guys are talking about something that you may own, but you may not know that much about… target date funds! Join Josh and Austin as they cover what a target date fund is, who target date funds are for, and the advantages and disadvantages that come along with target date funds. Tune in now!
Main Talking Points
[1:33] – What is a Target Date Fund?
[5:23] – Who Are Target Date Funds For?
[9:30] – Dad Joke of the Week
[10:27] – Advantages of Target Date Funds
[11:55] – Disadvantages of Target Date Funds
[16:59] – What if my Timeline Changes?
[18:54] – How Can I Invest in Target Date Funds?
[19:26] – Should You Invest in Target Date Funds?
[21:37] – Alternatives to Target Date Funds
Links & Resources
ETFs vs Mutual Funds – The Invested Dads
Invest With Us – The Invested Dads
Free Guide: 8 Timeless Principles of Investing
Social Media
Full Transcript
Intro:
Welcome to The Invested Dads Podcast, simplifying financial topics so that you can take action and make your financial situation better. Helping you to understand the current world of financial planning and investments, here are your hosts, Josh Robb, and Austin Wilson.
Austin Wilson:
All right. Hey, hey, hey, welcome back to The Invested Dads Podcast, a podcast where we take you on a journey to better your financial future. Today, we are talking about something you may own, but you might not know much about.
Josh Robb:
So we’re getting through my spices in my kitchen cabinet.
Austin Wilson:
Ooh, what is coriander? I don’t even… What are you… Tarragon?
Josh Robb:
Tarragon. Yeah. Sounds like a Lord of the Rings character.
Austin Wilson:
I use salt, pepper, crushed red pepper. I like cumin, Jenna’s not a fan of cumin. I like ground ginger in my Asian food. I like curry in my Asian food.
Josh Robb:
Stephen Curry?
Austin Wilson:
I like crushed red pepper flake. Ooh, Stephen Curry. Crushed red pepper flakes delicious, seasoned salts a go-to, I can go on all day.
Josh Robb:
Like Lawry’s?
Austin Wilson:
Yeah. Kind of the same thing.
Josh Robb:
On burgers? Yeah.
Austin Wilson:
Cinnamon. I use cinnamon on everything.
Josh Robb:
My wife is not a fan of cinnamon.
Austin Wilson:
Really? Steph there’s still time.
Josh Robb:
I know. It’s good.
Austin Wilson:
I’ll pray for you. So, anyway, yeah, not quite talking about the spices in your kitchen cabinet per se, but instead we’re going to be talking about target date funds.
Josh Robb:
Ooh. Target date funds.
Austin Wilson:
So target like with an arrow.
Josh Robb:
You’re aiming for something.
[1:33] – What is a Target Date Fund?
Austin Wilson:
You’re aiming for something, right? So let’s start 50,000 foot like we always do here. What is a target date fund, Josh?
Josh Robb:
Yeah. So the name really, like you said, target date fund, you’re targeting a certain date. All right? So are aiming for a date, a future date. So a target date fund is generally usually mutual fund. There are now some ETFs that are out there. Those are relatively new, but most time you see this in a mutual fund wrapper. And if you want to know the difference between those two, we did an episode on mutual funds and ETFs, check that out.
But it’s a target date, you’re aiming for a date and you want to have your investments adjust towards that date. So then the fund automatically changes their allocation as it gets closer. So you normally start aggressive and get less aggressive as you head towards that target. So high level, 50,000 feet, that’s what it is. It’s just a automatically adjusting fund instead of you having to go in and adjust how aggressive you are over time, it does it for you towards a date.
Austin Wilson:
Exactly. So for example, say Josh, you are invested in a target date fund in your retirement account and then you want to retire in 2040.
Josh Robb:
Yep.
Austin Wilson:
So you will probably select if you have done this the way kind of it’s designed, if you want to retire in 2040, you would select the target date fund ending around… They’re not always on the same exact year, but around 2040. So then that target is 2040 or when you need to start withdrawing money is the key there is when that target is set. So then 15 to 30 years, who knows what timeframe you started, prior to that date, the fund is most likely going to be in stocks or a good chunk early on, mostly in equities in stocks. And then the further you get to the retirement date to the target date, that stock exposure, that equity exposure is going to slowly ramp down and the fixed income exposure is going to slowly ramp up. So that the closer you get to retirement, you will have less and less volatility towards the end.
Josh Robb:
Yep. And the goal there is we talk long term investing, how stocks are the best thing to keep up with and beat inflation. But the goal of these target date funds is to reduce volatility as you head to that date. It’s not necessarily saying that at that age is what you should be in. It’s just saying that we know that for retirees, seeing big swings in the portfolio right around the retirement year can be stressful. And so that’s this target date fund just to say, “Hey, we’re going to reduce your volatility as you get towards that date.”
Austin Wilson:
And one thing that you point out a lot of times is that leading up to the few years leading up to retirement and the few years after retirement, the sequence of returns risk is highest. And kind of just take 30 seconds and talk about that.
Josh Robb:
Yes. So the idea there is given enough time, volatility is really not a big deal in your portfolio because we know historically speaking, the market is up the longer you give it, the more higher percentage of time you’re going to have a positive return. But if you shorten that time, your ability to actually see and experience losses becomes larger. So if you have a couple of years before, a couple years after that retirement date, that’s your most vulnerable time because if your portfolio is down during that time and you’re taking money out, it’s harder for that portfolio to recover because you’re at a lower point for the withdrawals and there’s less money to recover because you’re taking money out of it.
So yeah, that volatility in that short timeframe matters. That’s why getting a little less aggressive right around retirement may make sense for you. And it really just depends on how you’re approaching life. But again, as we talk about what target date funds are for, that’s one of the reasons why they’re very successful is it does help someone who doesn’t necessarily pay close attention to their portfolio. It’s having somebody do that for them.
[5:23] – Who Are Target Date Funds For?
Austin Wilson:
And that is kind of leads us into our next discussion is who are target date funds for? And the first thing that came to my mind is 529s.
Josh Robb:
Yes. You see those a lot.
Austin Wilson:
So, thinking that you’re putting money, dedicated money, tax-advantaged money usually aside for educational expenses. Okay? For generally children, but it can really be for anyone.
Josh Robb:
Yeah. Anybody-
Austin Wilson:
So you’re putting the money away you know a date. So roughly, and the one thing that you like to point out to me, Josh, is that just like for retirement, that target date for schooling, or it would be when you plan to withdraw, is the target not when you start school necessarily. Sometimes they’re the same. Sometimes they’re not, maybe you want to cash flow the first year or two or whatever out of pocket, and then start dipping into it later.
That’s kind of the target date that is being talked about there, but that risk is different as you’re preparing for school, like it is for retirement. So, when you’re trying to grow it, volatility is to be expected. You’re going to be pretty much all stocks almost. As you’re growing that money and the closer you get to school, the more likely you are to be needing that money. You want to keep as much of it as you can. So taking some of the risk off the table by increasing your bond exposure is how you’re going to be able to do that.
Josh Robb:
Yes. Yeah. Because for a lot of people, you may be able to postpone retirement a couple years if the market’s down, you can say, “I’ll just keep working.” For college, I mean you could delay college, but you really kind of graduate high school, “I’m going to go to college in a year or two.” You really kind of don’t have that flexibility. So yeah, it’s really popular. The other piece of it too and we’ll talk about this is 529s in that target moving towards it is college is a fixed expense. You can’t really adjust that. Whereas retirement, again, I could get a part-time job. Cashflow for college, especially in 529, that’s what it’s used for. You want to use it up for education. And so you want to make sure that your volatility is you’re aware of that so that you have the most amount to use since it is tax advantage.
Austin Wilson:
The other main bucket that you may see target date funds used for are retirement plans, obviously. And that’s the big example we talked about at the beginning. They’re very common nowadays in retirement offerings where, “Hey, you’re starting in the year 2020, and you’ve got a 2050 target date fund for your 30 years and yada, yada, yada.” That’s kind of how it’s done but it does the same sort of thing. It starts off very growth-oriented. And over time, really mostly towards that end is when it’s going to do a pretty decent size taper on bond exposure versus stock exposure there.
So those are kind of the two main buckets you would see these for, but in general, because you can now start to access these outside of retirement plans. You could get it in a Roth IRA. You could get it in a taxable account. Who knows? Any investment that you have a set date for that you want that money preserved for that date, that is an option. Now we’re going to get into our thoughts and our opinions on target date funds and whether they’re good or bad or what you should use them for or whatever here in a little bit. But generally speaking, if you don’t want to think about messing with managing your own asset allocation and things like that and risk over time, you just want to put money in and one thing and let it go, this is kind of the design.
Josh Robb:
In a sense, it gives you the advantage of holding a bunch of different investments and hiring a manager to adjust those over time because one target date fund is going to have a bunch of underlying investments within there because they’re building a full asset allocation. So, going back to that 2040, they’re going to hold different types of equity. They’re going to hold different types of fixed income, they may hold some real estate. Who knows how they build it out? But instead of you going out and finding 15 different funds to build a portfolio from, you buy that one target date fund, you’re good. And you know five years from now, it’s going to look a little different because they have this rules based to adjust it. I don’t have to remember to log-in in five years and make sure my allocation’s adjusted. So it is a nice advantage for again, somebody who maybe doesn’t want to spend as much time.
[9:30] – Dad Joke of the Week
Austin Wilson:
Absolutely. You know what is good though? A dad joke. It is dad joke of the week. Your Thursday dad joke of the week brought to you by r/DadJokes on Reddit. We’re not sponsored by them, but hey, if you’re listening, give us a call.
Josh Robb:
Somebody on Reddit that can give you a call like somebody that-
Austin Wilson:
I was thinking of Mr. Reddit, the guy who started Reddit. He read it.
Josh Robb:
Reddit junior.
Austin Wilson:
Yeah, he read it.
Josh Robb:
Family business.
Austin Wilson:
It’s a family business, third gen. So the joke is, Josh, six is scared of seven because 7, 8, 9.
Josh Robb:
Yeah. Everybody knows that, it’s good.
Austin Wilson:
But why did 7 eat 9?
Josh Robb:
Oh man. I don’t know why would 7 eat 9?
Austin Wilson:
Because you’re supposed to eat three squared meals a day.
Josh Robb:
Three squared.
Austin Wilson:
Math joke.
Josh Robb:
Nice. Love it.
[10:27] – Advantages of Target Date Funds
Austin Wilson:
Very good. Okay. So now what everyone’s really here for because the dad jokes are great, but these little life nuggets we’re talking about, this is what it’s all about. So let’s talk about some pros and some cons and kind of give our opinion on target date funds in general. So Josh, what are some advantages of target date funds?
Josh Robb:
And I just mentioned it, the simplicity, right? You don’t have to go through and evaluate a large cap fund, a small cap fund, a bond fund, a real estate fund. You could find a target date and know that there’s been some sort of a manager or a group or team or somebody has built this portfolio for you. So simplicity is really nice for that. One fund, I’m done. Most plans offer this now. So retirement plans and almost all college 529 plans because each state has their own. I believe they almost all offer this type of option. So they’re very widely available. A bunch of different companies have these depending on where you’re at, what your options are, but they’re all the same really there’s different nuances on who does what or how they do it. But in general, the overall concept is the same.
So, you know if you see a target, okay, I know what they’re doing there. And then depending on where they’re at, there could be passive or active or mixture of them, which is fine because you’re going to get, I mean, you’re really going to get the broad market returns, right? Maybe a little here or there, depending on what types of groupings they use active management. Yeah. But in general, you’re going to be diversified, which we’ve talked about is the key to long term investing is to having a diversified portfolio. So the advantages are simple, it’s available everywhere and you’re going to get a mixture of investments, both passive active, but it doesn’t matter because you’re diversified.
[11:55] – Disadvantages of Target Date Funds
Austin Wilson:
Yep. So let’s turn the page because there are definitely some disadvantages with this kind of structure. So number one, be sure you know your overall asset allocation. So if you’re invested, if you’re 10 years out or five years out from their target date on your target date fund, you should probably know what that asset out allocation between stocks and bonds is at that point to look in your total picture because maybe you have some Roth IRAs or some taxable accounts or something off to the side that’s not at your employer. So when you want to look at your total asset allocation, talk to your financial advisor about your plan, you need to know how your 401(k) is… Or whatever that asset is at that point is invested at that time. So understand your total asset allocation. It’s pretty easy early on with a target date fund with a long target way out there, because it’s generally speaking, going to be mostly equities to kind of not a such a big factor in your plan.
But as you get closer and that changes, you need to make sure that that’s overall aligned. Another one is that fees add up. So with mutual funds, ETFs, these products themselves have fees, right? But then often when you get them bundled together in these target date funds, there’s additional fees that are applied as well. And those can add up and fees are over time going to take away from your absolute gross returns and that is something just to be cautious of. It’s just how it works, but you could be nickel and dime and not really think about it because there’s layers there. The less layers you have, the more you’re going to be taking home in your return there. Another one is that some funds are better than others and your options might not be the best.
Josh Robb:
Yeah. So if you use the Ohio 529 plan, they use BlackRock. So the target date funds are run by BlackRock.
Austin Wilson:
You hate their software-
Josh Robb:
Good or bad? I don’t like their software, but they tend to rank pretty well actually. They’re one of the top 529 plans in the United States. But based on what company has it, you’re right. There may be good or bad choices depending on how they manage that.
Austin Wilson:
And if you’re at an employer, then you are ultra limited to what they have as options. So maybe they have an agreement with a certain fund company that handles all of their options. Then you’re pretty much tied to what they give you there. That’s the menu that you have to put your money in and they’re all going to have similar options. But within those similar options, there’s definite better ones and not as good ones there. Another one is that most target date funds hold funds managed by the same company underneath. So if BlackRock is the target date manager, they are using BlackRock funds underneath. So just something to be cautious of. It’s not necessarily bad, but you really have all your eggs in the BlackRock management basket at that point. For example, there’s a lot… Any of the company’s going to do the same thing because they make more money as they’re using their own products.
Josh Robb:
Right. And when you go back to fees, a lot of times when they build a 529, they’re using those underlying strategies. So you actually do save a little on your fees total because you’re not taking everybody’s fees and grouping them and then adding another manager on top. So there’s advantage and disadvantage to it, just keep an eye on it. Not it’s horrible, just know that.
Austin Wilson:
There’s also been some criticism because when you’re looking at financial planning, obviously we’re planning generally speaking for people their entire lives till death and beyond at that point. And a lot of these target date funds really get people focusing on the retirement being the end of the plan. And that’s really not the truth or the 529 being that’s beginning of college is the end of what this money is used for which in that case, it kind of is. But specifically when it comes to retirement, there’s a lot of time after retirement, hopefully, that this needs to be managed for. So getting people to focus well beyond the target date is really the goal here. And it really keeps people a little bit too shortsighted in most of the… Not most of, in a lot of industry experts’ minds.
And another one is that this is generally speaking, that asset allocation shift over time is gradual, but it’s rules based. There is not a human, generally, not a human person saying, “Well, I think stocks are overvalued a little at this point. So I’m going to actually pull this down a little ahead of time. I’m going to let this happen on its own.” There’s no manager who’s going to be saying, “Okay, well this is maybe not the right time for this target date fund to shift.” It’s this is the rule and it’s going to shift on its own.
Josh Robb:
A good example of that is, if they said every three years we adjust the allocation and that happened to fall on 2008, when the market’s down, they’re just going to adjust the asset allocation because that’s rule and not overlaying-
Austin Wilson:
And what’s that do that makes you sell stocks when they’re down?
Josh Robb:
Yep. If you’re getting less aggressive. Yep.
Austin Wilson:
Exactly.
Josh Robb:
So, that’s the one aspect. But again, sticking to rules in planning sometimes is the better option instead of trying to time it. But there’s situations where using your own brain sometimes would say, “You know what? Let’s just wait a little bit longer and see what happens.”
[16:59] – What if my Timeline Changes?
Austin Wilson:
So the question that you’re thinking as you’re listening to this, driving down the road in traffic probably is what if my plan changes? What if my retirement goals, what if my timeline changes? So Josh, what do you think about that?
Josh Robb:
Yeah. So with this, you’re holding a fund, you’re holding an investment and if we’re talking retirement, you would just change your target date. Which is nice.
Austin Wilson:
Yeah. Which is sell a fund and buy a fund.
Josh Robb:
Sell and buy. And so then underlying assets would be more or less aggressive depending on what direction you’re moving. Same as with 529 plans because it’s an individual holding, you could just sell that and buy a different target date. So that’s pretty easy. The plus side to that is that choosing your own asset allocation, if you’re looking at say just isn’t quite what I want, you could choose a different target date based on where you want it to do. Because again, when you look at these funds, they’re very clear on what their goal is. They’ll tell you in their perspectives, when they’re switching, how much they’re switching, where the end result is going to be. If you look at it and say, “Well, that doesn’t line up with my time.” Choose a different one. It’s pretty easy.
Austin Wilson:
Because it can go both ways. You could trade for a target date that’s further out and that is going to postpone the change in stocks to bonds allocations or you could get one that’s closer than the original and that would then speed up, essentially is what that would be doing there. One thing I want everyone to do if they’re not driving, so don’t drive, don’t do this and drive. Two hands on the wheel if you’re driving. If you’re not driving, put your right hand up and say, “I, insert name here, will not take my money out prior to retirement.” You should only-
Josh Robb:
To avoid the penalty.
Austin Wilson:
Yeah. You should only be changing this if your retirement date is changing-
Josh Robb:
Or you’re not planning a withdrawal.
Austin Wilson:
Exactly.
Josh Robb:
You could change the retirement date, doesn’t mean you have to take the money out when the number hits. In fact, when it hits there, that’s what they consider the distribution phase. They maintain a pretty stagnant asset allocation going forward after it hits that date on what’s considered a distribution or an enrollment phase.
[18:54] – How Can I Invest in Target Date Funds?
Austin Wilson:
So everyone’s favorite part of these series is pretty much how can I invest in these? And I’m not going to give you a list because-
Josh Robb:
There’s a lot out there.
[19:26] – Should You Invest in Target Date Funds?
Austin Wilson:
There’s a thousand target date funds from a hundred providers. I may be exaggerating or not. I might be undershooting. But generally, there are ETFs and mutual funds now that are giving you the options to do this. So talk your provider if it’s a work-related plan or you can do some research at any of the major asset managers are going to have options like that. But the question for Josh, I love asking Josh questions because he’s my financial guru. Josh, should you invest in target date funds?
Josh Robb:
That just depends. Surprise, surprise.
Austin Wilson:
Okay. I’ve never heard you say that before.
Josh Robb:
Yes. But it really depends on your financial situation and what your goals are. I see it used a lot in 529 plans and I think it makes a lot of sense in there. You’re heading towards a date. At that date, your plan is to pretty much fully distribute the money in that account. Most people, when they have 529 plan, they don’t really carry much a balance after that. So it makes a lot of sense. If you don’t want to build asset allocation, you don’t want to spend time adjusting funds and trading, which by the way, you only get two adjustments per year in a 529 plan.
Austin Wilson:
Oooh, use them wisely.
Josh Robb:
So this is a nice way of holding a fund that is going to keep an asset allocation consistent and getting less aggressive along the way. So should you invest in it? It really depends, but that is one spot that I do see a lot of opportunity for 529 plan to utilize a target date because that is a very clear target that you’re trying to get to.
Also, really depends on how much you like to do versus having somebody else do it. If you say, “You know what? I don’t have the time, the desire or the expertise to pick what I want to own, then by all means let somebody else do it.” Whether that’s hiring an advisor or having a target date fund. Now you may have an advisor recommend a target date fund because they say, “You know what? This is a well managed fund. It’s doing the thing. It’s going to be cheaper than another way of doing it, hold that.” But make sure you talk to your advisor, make sure it fits in there, but overall there’s nothing wrong with them. They’re a great way of self managing a target asset allocation.
[21:37] – Alternatives to Target Date Funds
Austin Wilson:
And I think you hit the nail right on the head, talking to an advisor’s going to shed a lot of light on the situation. They can advise if they think this is a good option for you, based on how you and your mindset works with planning that can work for you. But they may have options to do this for you with using individual funds and individual ETFs, individual stocks and bonds, however they want to do that can be a little bit more detailed and a little bit more specified to you, which because everyone’s financial situation is different. And that’s why we always recommend talk to an advisor. I think that that is the best bang for your buck in the business there, which brings us to… Alternatives to target date funds. What are some alternatives?
Josh Robb:
Yeah. Well, like you mentioned, an alternative would be building your own asset allocation portfolio-
Austin Wilson:
B-Y-O-A-A-P.
Josh Robb:
Yeah. That works.
Austin Wilson:
BYOAAP.
Josh Robb:
BYOAAP. And that’s the new acronym, but the idea would be doing the same thing that the target date fund does for you is you say, “Okay, I need this percentage in large cap, this percentage in small cap, this percentage in international, I’m going to go find the fund. I’m going to build it. And then I’m going to periodically adjust it until I get to that date that I’m trying to do.”
Austin Wilson:
So what’s the main benefit that you’re avoiding?
Josh Robb:
You’re avoiding the timing of those adjustments. The main thing you can do is say, “I choose when I go less aggressive or more aggressive, whatever I’m doing in my adjusted allocation.”
Austin Wilson:
Well the last thing you want to do-
Josh Robb:
I control it and I don’t want to sell the stock in 2008 when the stock is down.
Austin Wilson:
That’s just it. That’s the last thing you want to do is sell the stock when it’s down.
Josh Robb:
Yep. Alternative is you’re taking those rules away and applying them yourself. So if you feel the need to do that, great. The other alternative is they now have asset allocation funds that are instead of target date, so a moderate, a conservative, and aggressive, and you could just work your way down those, which would still give you the asset allocation but the adjustment would only happen when you trade the fund. So an in-between between building your own portfolio and a target date is an asset allocation type fund where it says moderate or aggressive or conservative and you just work your way down the ladder as you get closer to your arbitrary date that you build.
Austin Wilson:
Yes. So that’s target date funds at a high level, in a nutshell. Any other euphemism you have for wrapping things up? That’s the word I’m looking for.
Josh Robb:
That’s all folks.
Austin Wilson:
So that’s it. But two things, two reminders. Number one, it’s not too late to enter our second half stock draft competition, even though we’re a halfway through the second half.
Josh Robb:
Are we halfway through the half of the second half? Halfway through the half.
Austin Wilson:
Yeah, but so we are halfway through the second half. You still can join with a fresh hundred grand of fake money and you might beat Josh.
Josh Robb:
You will beat Josh.
Austin Wilson:
Number two, as always check out our free gift to you. It’s a brief list of eight principles of timeless investing, overarching investment themes to keep you on track to meet your long term goals, check it out. It’s free on our website. Josh, how can people help us grow this podcast?
Josh Robb:
Yeah. Make sure you subscribe. That way, every Thursday you get the most recent episode sent directly to you. Leave us a review on Apple Podcast. It’s always great. It helps more people find us, meaning more people can hear about getting better with their financial future. And then if you have any ideas or have any questions, shoot us an email at hello at theinvesteddads.com. And then lastly, if you know somebody was asking about target date funds or is using a 529 or something and needs help with that asset allocation, share this episode. Maybe this will be useful for them.
Austin Wilson:
Well, until next Thursday, have a great week.
Josh Robb:
All right. Talk to you later.
Austin Wilson:
Bye.
Outro:
Thank you for listening to The Invested Dads Podcast. This episode has ended, but your journey towards a better financial future, doesn’t have to. Head over to theinvesteddads.com to access all the links and resources mentioned in today’s show. If you enjoyed this episode and we had a positive impact on your life, leave us a review, click subscribe, and don’t miss the next episode. Josh Robb and Austin Wilson work for Hixon Zuercher Capital Management, all opinions expressed by Josh, Austin or any podcast guest are solely their own opinions and do not reflect the opinions of Hixon Zuercher Capital Management. This podcast is for informational purposes and should not be relied upon for investment decisions. Clients of Hixon Zuercher Capital Management may maintain positions in the securities discussed in this podcast. There is no guarantee that the statements, opinions, or forecast provided herein will prove to be correct. Past performance may not be indicative of future results. Indices are not available for direct investment. Any investor who attempts to mimic the performance of an index would incur fees and expenses, which would reduce returns. Securities investing involves risk, including the potential for loss of principle. There is no assurance that any investment plan or strategy will be successful.
