How Target Date Funds Blend Assets Into A Single Fund
Target-date funds combine a mix of assets in a single fund, so that you capture the return of stocks while holding other assets to manage risk. The asset mix of a target-date fund changes as you age. That usually means the proportion of stocks declines and the proportion of fixed-income assets rises as you approach retirement.
The Importance of Fees
When picking a target-date fund, you should pay attention to fees. Unlike in other areas of life, within finance, fees typically don't mean a better product; in fact, fees eat into your savings, so if you can lower your fees you should likely enhance your returns. At FutureAdvisor, we consistently recommend low cost funds for this reason. Target date funds often have higher fees than other exchange traded funds (ETFs).
|Vanguard S&P 500 ETF (Ticker: VOO)||0.05%|
|iShares Trust Core MSCI EAFE ETF (Ticker: IEFA)||0.14%|
|iShares Core MSCI Emerging Markets ETF (Ticker: IEMG)||0.18%|
|Vanguard Total Bond Market ETF (Ticker: BND)||0.08%|
Sample low fee ETFs as of October, 2014
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The Limitations Of Target Date Funds
Target date funds do have several limitations. The first one is tax efficiency. To maximize your returns after tax, it can be helpful to put different investments in your taxable and tax-sheltered accounts (401(k)s, IRAs etc.). However, a target date fund is a single fund and the different components cannot be split across accounts. Secondly, in taxable funds, tax loss harvesting can help after-tax returns. Again, target date funds cannot do this because they are a single fund. Target date funds are also not sensitive to other investments that you hold, such as stock in your employer, whereas a service like FutureAdvisor can take account of your other holdings and balance allocation accordingly. Finally, a target date fund can be something of a black box: you don't know what you're holding or whether it's really attuned to your specific risk tolerance or specific retirement age, rather than a 5-year window.
Target date funds are definitely an improvement over the retirement savings plans that many have, but they do have some limitations that a customized portfolio provided by a service such as FutureAdvisor can address. FutureAdvisor can create a unique and tax efficient portfolio for your needs, and we show you how to do it for free after answering a few simple questions about your age, risk tolerance, and goals.