Should I simplify my retirement accounts and invest in target date retirement funds?
I have diversified accounts at both Fidelity and Vanguard. About four years ago, a fee-based financial planner reviewed my accounts and recommended certain allocations and funds, which I followed. I'm currently 56 years old. I don't manage my accounts especially well individually and don't want to continue paying for fee-based planning. I've been a fairly aggressive investor in the past. I'm thinking of selling most of my funds (keeping them within the 403 b structure), taking the money out, and putting majority sums in a Fidelity Freedom fund and a Vanguard Target date fund. I plan to retire in a few years, but don't intend to access the retirement funds in the 403 b accounts until I'm 70. Is this a good plan?
This is a very good question and I’m sure one that many people have. There are three main parts to your question: 1) Should you simplify your retirement accounts? 2) Should you use target-date funds? 3) Should you continue to use a fee-based financial planner?
1) SIMPLIFYING YOUR RETIREMENT ACCOUNTS
It is difficult to give specific advice without knowing more about your financial situation. I don’t know how complicated your investments are nor do I know the number or types of investments you own. Therefore I can only provide general statements. That said, in my practice I have seen many examples of overly complicated retirement accounts. Often, new clients come to me with a hodge-podge of different investments and no real plan regarding how they fit together into a unified portfolio. For example, if you hold many mutual funds (15-20+) you should think about cutting down the number of funds. When you own a large number of mutual funds you could be paying higher fees, for possible outperformance by active management, but end up with disappointing returns. Owning too many mutual funds can, unfortunately, end up delivering index returns, or much lower, while incurring additional costs.
Target-date funds were created back in the early 1990s to provide a single mutual fund that could be owned in a retirement account for decades. The “target-date” in the fund name is (usually) the date at which you expect to retire. The idea is that you choose the fund based on your projected retirement date and then forget it. Two main benefits of the target-date fund are that it automatically adjusts the asset allocation over time, to be more conservative as you approach retirement, and performs rebalancing without your intervention. Additionally, the funds are usually well diversified and low cost.
The major disadvantage of a target-date fund is that it is a one-size-fits-all solution. The simplifying assumption behind the fund is that everyone retiring in the same year is the exact same type of investor, with the same risk tolerance, time horizon, liquidity needs, tax situation, outside investments, income, etc., etc. This is a very big assumption, which is obviously incorrect, and is the reason why I do not use them in my practice. My investment advice is tailored to each client and his or her own particular financial situation.
But for people who are managing their own retirement funds and have a very simple financial situation, a target-date fund could be useful. They are certainly an improvement over a non-diversified, static portfolio.
Even when choosing target-date funds, you must be aware that not all funds are created equal. Each fund sponsor (Fidelity, Vanguard, Schwab, etc.) comes up with their own idea of how these funds should be constructed. For instance the Fidelity Freedom® 2025 Fund (FFTWX) has 47.7% in US equity whereas the Vanguard Target Retirement 2025 Fund (VTTVX) has 39.5% in US equity. The expense ratio for the Fidelity fund is 0.69% while the Vanguard fund is much lower at 0.15%. So even in the realm of target-date funds you have to do your own research to find the best investment for your situation. Which brings me to your last question.
3) PAYING FOR FEE-BASED PLANNING
I chose to enter the investment management field because I saw the need for unbiased, professional investment advice. As you said, you haven’t managed your own accounts especially well, which is not your fault. Most individuals have their own busy lives to lead, demanding jobs to attend to and do not have the time or inclination to become investing experts. I believe, and research studies have shown, that good investment advice can more than pay for itself overtime.
That said, deciding on whether to manage your investments yourself or hire a professional is a very personal one and depends upon your situation. Again, you did not provide any financial details so I can only give a broad answer. In general, the more your investments are worth and the more complicated your situation is, the more you could benefit from a financial advisor. In addition to investment advice, a financial advisor can help you with a number of retirement items such as Social Security planning, long-term care insurance, life insurance, taxes and estate planning. Another option is that you could hire an advisor for a one-time consultation, instead of on-going management, if you are sure you will implement his or her advice.
If you decide to continue to work with a financial advisor you should understand exactly how they are compensated. For example, there is a difference between fee-based and fee-only. You should also make sure he or she has a fiduciary duty to you regarding all of their recommendations.
If you decide to manage your own retirement investments, keep it simple, stick to a plan, rebalance as needed, and do not watch your accounts more than once per quarter.
Thanks for the question. The answer depends on a few things. My main concern would be this: you said you have trouble managing the accounts. A target date fund would change your allocation automatically, but would not give you advice about planning concerns, including Social Security, distribution strategies and the like. So, I think it really depends on what your issues have been with self management.
The choice of having an advisor or doing it yourself is the heart of your question and it is one I have been asked many times. I cannot tell any individual whether it is worth it or not to pay me or any other advisor for help. For the average person, I believe do-it-yourself investing is not advisable. Part of that is experience, but the other part is this: Vanguard itself conducted a comprehensive study that found advisors added significant value to clients.
To summarize, I think this answer is highly personal and there is no specific recommendation I can give you. If you have the experience, discipline, time and temperament, you can save the fee. If you do not, you may end up costing yourself more than what the advice would have cost in the first place.
I would need more information to determine what would be a good plan for you individually, but there are potential drawbacks of target-date funds. Unfortunately, they are not the one-stop shop that they are often advertised to be.
- Target-date funds are not specific to your individual situation and there is no consideration of your individual propensity for risk. Two individuals who retire in the same year may have very different risk tolerance levels – the level of volatility that you can personally handle – and the funds make no consideration for this. It is far too simplistic of an approach to assume that each person retiring in the same year should have the same investments in their portfolio. These target funds also naturally have no consideration of your total financial situation – investable assets, real estate, business interests, debts, cash flow issues, etc.
- Tax efficiency is not a consideration in target-date funds. They should not be used in taxable accounts. The fixed income portion can contain taxable income generating instruments, the equity portion can contain taxable income generating stocks and the turnover ratio is not managed with tax-efficiency in mind, causing potential capital gain issues.
- Allocation can be adjusted and shuffled at the fund manager’s will. Again, this increases the potential tax burden. Although there is a stated post-retirement target mix, for example, ‘becoming more conservative until it reaches an allocation of x% equities and y% fixed income; z-years after retirement’, the fund manager is not held to any specific allocation path in the time leading up to this date or once the target retirement date is reached.
- Funds have demonstrated a lack of consistency across the board in ‘glide path’ construction. The glide path relates to the allocation of the funds once the target retirement year is reached. For example, the allocation path of the fund does not know whether the fund will be retained and used to support the retirement income needs of the investor over time, or if the funds will be withdrawn and spent at or near retirement. It is logical that the allocation of a portfolio should be different for an investor who is actively withdrawing from the portfolio, than an investor who has no plans to draw from the portfolio yet these funds make no distinction.
Short answer: Sure, target-date funds have their drawbacks, but they may not matter for you. If your goals are to maintain a diversified portfolio of stocks and bonds and adjust your asset allocation toward less volatility as you approach your target date, all with a minimum of attention or effort, this could be a fine plan. It will have a cost, of course, but that cost may be inconsequential in your situation. Most of the other professionals who've answered this question have saved you some Googling time by providing many of the drawbacks of target-date funds, so make sure you read their answers, but I'm going to skip that. A couple of things that I think were missed:
- Diversification– The Vanguard fund you mentioned in your question invests of a blend of four OTHER Vanguard funds. One of those other funds holds around 3,500 stocks. The “smattering” of international holdings in each of the funds you mentioned is (as of this post) around 27%. As far as stocks and bonds are concerned, there’s a fair amount of diversification here.
- Primary Goal– What’s more important to you? Squeezing every dime possible out of your retirement investments or setting up something that you feel may or may not be precisely tailored to your needs, but you feel it’s good enough to not think about it every day. If you’re on-track to have more than enough money to satisfy your needs in retirement, maximizing efficiency may not matter to you at all.
More complete answer: In order to evaluate whether this plan will work for you, you need to do some of the work of the advisor you'd like to replace. In the simplest terms, you need to evaluate the possible situations for two things:
- Do the expected returns from this combination of investments provide enough capital growth to fulfill your expected needs from this subset of your overall portfolio?
- If so, can you stomach the probable periodic declines in portfolio value that may be associated with this combination of investments?
“Expected Returns” is never an easy nut to crack. Typically, one would look at past performance and use that to make a conservative educated guess at what the investments might return in the future. With target-date funds, though, the investment mix changes over time, so the expected annual return will change over time as well, complicating the calculation. You can find the most of the data you need by looking at the fund’s details on their web site or the free sections of Morningstar. Financial advisors have planning software that does this work, but if you’re handy with spreadsheet software, you can still do it. If your calculation yields an acceptable amount of funds to meet your goals, move on to the second requirement. If the target date fund allocation won’t meet your needs, evaluate your options again. Other choices include (but aren’t limited to) keeping the funds invested longer than original planned time frame, increasing contributions to the investment portfolio, lowering expected expense expectations in retirement, or increasing the equity allocation in the portfolio.
Evaluating probable declines in portfolio values can be tricky with target-date funds, too. How much the fund could drop in response to market conditions is going to depend on the portfolio allocation at the time. It’s part of the reason the funds exist, as you get closer to the target date, the funds consist of more fixed-income investments and cash. Theoretically, they’ll drop less in value in a down market. The biggest drops should then occur before the fund enters its “glide path” and starts changing allocation. If your chosen funds aren’t in their glide path yet, look up their worst 6-month, 1-year, 3-year, and 5-year period. Then ask yourself what you would do if the fund dropped more than that in a corresponding period. Would you hold on, relying on the statistical probability that you’ll see recovery? Would you sell out of either panic or a belief that you could do better? In other words, could you REALLY “set it, then forget it?” If not, you may consider choosing a less volatile asset allocation, then starting again with the first question.
Good question. It would simplify things, but would not lead to a more diversified portfolio. Target date funds tend to invest primarily in US equity mutual funds and US bond funds, with a smattering of non-US stock and perhaps a real estate fund. What I would suggest (and what I personally do) is build a broadly diversified portfolio of funds at Vanguard or Fidelity (or both). In as much as you already have funds at Fidelity and Vanguard, your portfolio is already diversified to a certain degree.