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?

Retirement, Asset Allocation, Retirement Plans
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August 2016

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.

2) TARGET-DATE FUNDS

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.

Best wishes,

Arden

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