Capitalist Investor

Target Date Mutual Funds Explained: Pros, Cons, and Smart Investment Tips, Ep. 277

• Strategic Wealth Partners

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In the latest episode of the "Capitalist Investor" podcast, hosts Derek and Luke dive deep into the nuances of retirement planning, with a special focus on target date mutual funds.

 1. Target Date Mutual Funds: An Overview
The episode kicks off with Derek and Luke explaining what target date mutual funds are. These funds, offered by financial custodians like Fidelity and T. Rowe Price, aim to simplify retirement planning. They are named after a target retirement year and automatically adjust asset allocation over time as one gets closer to retirement. For instance, a 2045 fund will be more aggressive today but will gradually become more conservative as 2045 approaches.

2. Pros and Cons of Target Date Funds
The hosts delve into the advantages and disadvantages of using target date funds. On the plus side, they offer a hands-off approach to investing, as they automatically become less aggressive with time. However, this automation could lead to timing issues, as these funds do not adjust based on current market conditions, potentially leading to suboptimal performance.

3. Hidden Costs and High Fees
Luke highlighted a critical drawback of target date funds: their fees. While they provide a convenient way to invest, they often come with higher expense ratios that can eat into your returns. Luke mentioned that fees can be as high as 1% annually, and these costs might not justify the simplicity they offer, especially when you consider that these funds often just track standard indexes like the S&P 500 and the aggregate bond index.

4. The Importance of Active Management
The hosts stress that while target date funds are designed to be a set-and-forget option, they lack the flexibility to respond to market changes. This lack of adaptability can result in missed opportunities or heightened risks. Luke pointed out that the evolving job market means younger investors are less likely to stay with one employer—and one 401(k)—for decades. This shift makes active management even more crucial.

5. Rethinking Conventional Wisdom on Investment Strategies
Toward the end of the episode, Luke challenges the traditional wisdom that simply investing in the S&P 500 for 40 years will guarantee wealth. He notes that relying solely on historical performance might be risky in our current economic environment. Luke suggests that even for young investors, a more balanced approach—like a 60/40 portfolio—might offer better risk-adjusted returns.

The latest episode of "The Capitalist Investor" sheds light on the complexities of target date mutual funds and the broader landscape of retirement planning. With thoughtful insights into the pros and cons of these funds, the importance of active management, and the need to question conventional wisdom, Derek and Luke offer valuable advice for investors at all stages of their financial journey. Whether you're a young professional or nearing retirement, this episode is packed with information that could help you make more informed investment decisions.

Hello, and welcome to this week's episode of the Capitalist Investor. As always, you have me, diamond hands D and cool hand Luke. How we doing, bud? Not too cool. Not too cool. It's kind of. Kind of hot today. I don't know if I'm getting. You see, you get cold, if you get sick. I don't know. I feel, like, congested. I'm burning up or something. Yeah, I'm getting. Am I going through, like. Could be. Could be. All right, well, I don't know how to segue out of that one. There's no good way to. We'll just dive right into it. We've got good old retirement planning today. The planning corner that is usually Tony Zabigalo's favorite. Tony the Tigers. But he's not here. He's on assignment. But we got today, target date mutual funds. Yeah. Are there so much fun to talk about target date mutual funds? Well, yeah, you know, I feel like. I feel like it's actually a pretty good topic to talk about because when I'm talking with people out there, you know, obviously, my clients don't really have them anymore. But as people come in here initially, it's a very easy and popular, I would say, way to invest, especially inside of people's 401 ks. So it's a really good idea to kind of dive into what the pros and the cons would be of those target date funds, because there are some of both. But let's kind of dive into exactly what they are before we get going. So when we say target date funds, it's fidelity has them, tro price has them. Essentially, every financial place custodian has a target date fund. And what exactly it is, it'll say fidelity, and that'll give a year. So 2045. And the idea is it's supposed to be the year in which you retire. So, and basically, as, as you get closer to retirement, so as time goes on, that 2045 fund is going to get a little bit less aggressive over time. So, so basically, if you were in a 2025 fund right now, that would be one of the least aggressive. So the balance between stocks and bonds would be closer to probably a 60 40 at that point, whereas, like, a 2045, where I mentioned earlier, would probably be around, you know, probably 7530-7525 something like that. So they basically adjust for risk over time. Well, and that's why a lot of people have them and why the 401K providers have them is because they're perceived to be kind of the way to invest without being involved. If you have a 90 ten portfolio, and you're aggressive. 90% stocks, 10% bonds. When you're 25 years old and you buy a 2055 2060 mutual fund, that aggressiveness should come down without you having to do anything, assuming you work the same job for 30, 40 years. Now, here's my quick issue, is the 30 40 year old or 20 year old is not working usually the same job for 30 40 years anymore like he used to be. So there always has to be kind of the active, more component involved. But like you said, it's good that it's helping people get involved, taking on the investments for them, managing the risk for them, but also the fees in these usually can be pretty high. I've seen upwards of, whether it's tro, whether it's these other companies, usually Vanguard's a little cheaper, but like, you know, sometimes they're upwards of 1% every single year, and you don't really know what you're getting. Like, for that 1%, you don't know what exactly. Usually they're, you know, really they're just investing the S and P 500 in the aggregate bond index. They're not really doing too much more sophisticated than that. So you're paying 1% to get the same exposure you would buying the spy or QQQ ETF in the Agg you throw on the bond side of, and then you're not getting tax advice, you're not getting retirement advice. So it's just these fees usually can be a little high. If you do have these, make sure you just check your expense ratios. Yup, for sure, because you said it there. So. And I would say that's probably what I'm about to say is probably one of the biggest drawbacks to these target date funds. They adjust over time. They don't adjust based on what's going on in the market. So you can get timing issues right. So where 2045 fund says, beginning of third quarter, we're gonna get a little bit less aggressive. But what's actually going on in the market, you might want to get a little bit more aggressive. It's gonna take that out of your hands, essentially, which is why they typically underperform just regular market indexes, is because as they're adjusting, that can lead to timing issues. Because the goal isn't to time it right. The goal is just to reduce the risk on a schedule. Well, reduce the perceived risk. I don't want to go too far deep into this. This is a retirement planning corner, but this always goes, listen, every conference I go to every dinner I go to around this industry, everyone's like, all you got to do is invest in the stock market over time. In 40 years, you'll 8% compounded. Every year you'll retire with a couple million dollars. That's what every person says, because they're using history as a gauge for the future. So history says, if you looked at history, that stocks will outperform bonds and stocks will do really well. Small cap stocks always win in the end because America is always growing. So that risk adjusted is using history, 90%, 1080 percent, 20, depending on how old you are. That's all using history. I think this world and environment we're heading into, you can't always use history as a gauge for the future when it comes to risk, when it comes to the management of your portfolio. So that's my only issue sometimes is, you know, when everything works for everybody, things tend to not to work anymore. Right. And it seems like the whole philosophy of all you gotta do is save into 401K for 40 years and pump money away and invest it in the S and P 500. That's all you need to do to become wealthy. Everyone seems to be doing it now because it's kind of built that way. The structure's built. I don't know if that's the way anymore, necessarily. Just throwing a big curveball in at the end, huh? Yeah, I like it. So expand on that a little bit. I just think that you have to be more conscious of where you're placing your money. You have to be. Look, 401 ks are built for the tax, getting tax deductions in the industry. Taxes are the number one hindrance twelve. So yeah, you need to save money into your 401K, but also understanding that when the markets rallied so much off the bottom in bonds were paying 5%, that bond portion, your portfolio, like when rates come down, actually do pretty well. So I'm not saying you have to always try to time things perfectly, but like, even if you're younger right now, I know this sounds crazy, but I think, like, the bond portion of a portfolio could be a great hedge to actually make money on a portfolio on that side of things. So like the 90 ten aggressive portfolio, like, you know, taking risk into account, maybe it makes sense to be like 60 40. Like the 60 40 you might be back is what I'm saying, for even a younger person. Yep, absolutely. That's an excellent point, because we saw that, right in 2022 with, I think the aggregate bond market in 2022 was down probably it was 20%. Yeah, it was down just as much as stocks. So whatever goes down quick can come up quick. Whatever goes up quick come down quick. So yields going up quick could come down very quickly. All it takes is one thing to break. Yep, for sure. So I'm not saying it's gonna happen, but I'm just saying from a risk standpoint, I don't know, bonds might be a little more attractive from even an investing accumulation standpoint. Yep, for sure. So yeah, keep in mind you're not necessarily usually a 401K is a savings vehicle, a tax deduction vehicle like Luke just mentioned. You're usually not trying to kind of time the market and things like that. It's meant for a long term savings. However, you know, what Luke just said is super important. You just don't want to put it on autopilot. And just to clarify, I'm not usually referencing, I talked about that whole spiel. I'm not referencing the 60 year old, the pre retiree, the retiree that still has their money in a 401k. I'm talking about someone that's 25, that's 30 years old that wants to plan for the next 30 or 40 years. I just don't know if we're going to see the past 30 40 years. Even with the, the boom and bus cycles 0809 tech crash. I don't know if you're going to see as much recovery so quickly like you did in zero eight. I know two thousand's where there's kind of the lost decade, 2000 to 2010, but just feels like a lot of this was pulled forward, that's all. I'm just saying if you're young. Informational. Purposes and are not intended to provide specific advice or recommendations for any investment, legal, financial or tax strategy. It is fully intended to provide education about the financial industry. Please consult a qualified professional about your.