Why I Ditched My Target-Date Fund

There are times in life when you’re not going to want to be involved with certain projects. For example, I want nothing to do with home or auto repairs. 

When something I own breaks down, nothing brings me more pleasure than calling a handyperson or a mechanic I know and having them do all the work. 

I don’t want to know how they “make the hamburger” or do the repair. I just want to know it was “cooked well and delicious” when it’s finished.

At one point in my life, I felt the same way about my 401(k). 

But now, I feel differently. 

Here’s why I started taking an active interest in my 401(k), and why I ditched my target-date fund – and you should, too.

When the 401(k) Man Comes Around

Back in 2014, I was first starting out in the game of digital marketing for a semi-famous blues musician. My 401(k) was my first major retirement vehicle and I was excited to have it. But I wanted really nothing to do with managing it at all – I was happier just letting it be.

I remember when the man representing the mutual fund company came to talk with all of us employees of the semi-famous blues musician. 

He explained why saving for retirement was so important and how we need to be sure to allocate a certain percentage of every paycheck to the 401(k). After that, he told us about the very generous employee matching program that we had (particularly as compared with most other companies and semi-famous blues music offices).

Then he told us what to invest in. 

And I don’t mean that he recommended a bunch of stock picks or gave us some general sense of how to invest our 401(k). 

I mean he literally told us what to invest in. 

The 401(k) plan had many different options, but at the end of the day, he told us that there was really only one right option.

And that was a target-date fund.

What Is a Target-Date Fund?

But what is a target-date fund?

Well, target-date funds are mutual funds – actually they are generally a fund of funds – with a pre-determined asset allocation. That allocation automatically adjusts or “glides” from the more risky to the more conservative as you get close to your target retirement year.

For example, let’s say you plan to retire in exactly 30 years, in the year 2050. If you invested in such a target-date fund (also sometimes known as a life-cycle fund or an age-based fund) today, over the course of the next 30 years it would adjust from a more to less risky asset allocation.

Now, the exact allocation will differ from fund to fund. But in one hypothetical example, the fund may start with 85% of one’s assets invested in stocks, and the rest in bonds and cash. 

But as you get closer to age 50, the fund may drop all the way down from 85% stocks to only 50% stocks. This is a far more conservative asset allocation because bonds and cash equivalents are generally less risky than stocks.

You Must Invest in a Target-Date Fund… Right?

Anyway, the very nice man from our 401(k) mutual fund company told us we absolutely had to invest in the target-date fund. 

Of course, he didn’t mean this in a legal sense; legally we were free to choose any of the retirement plans they offered officially. But, he assured us, the target-date fund was the only option that made any sense for us.

Based on conversations I had with fellow coworkers after the meeting, I’d say at least 90% of us working for the semi-famous blues musician decided to go with the appropriate target-date fund for our projected retirement year. 

But I was a little uneasy. In fact, as both of my parents had been stock traders before they retired, I thought I would consult with them and see if some of the other options made more sense for me.

I explained my hesitations to the nice 401(k) man when we spoke one-on-one, but he pushed back at me. He said I had absolutely no business trying to actively manage my retirement plan, my Bachelor of Science in finance and my well-informed parents be darned. 

Since he objected so strongly and I didn’t really know all that much yet about investing, I figured it was the right move. So, I obliged and invested in the appropriate target-date fund that projected out a 30-year retirement date. 

Set it and forget it. Case closed.

Or was it?

Why Target-Date Funds Are Popular

Target-date funds are becoming more popular as retirement vessels than ever before. According to a recent study of Vanguard fundholders – one of the biggest 401(k) mutual fund companies out there – 52% of their fundholders invested in a single target-date fund. 

In other words, if these people had all of their retirement money in their 401(k), their entire retirement nest egg was placed in one of these target-date funds. Only one. 

And Vanguard projects that these 52% of participants will only keep growing.

A decade ago, only about one-third of companies even offered target-date funds as an option for their employees. 

Now, that number is all the way up to 90% of companies. In other words, target-date funds are simply everywhere.

And it’s pretty easy to see why. After all, a target-date fund is the ultimate set-it-and-forget-it retirement plan. You literally just dump all of your money in the fund, ignore it for 30 or 35 years, and voila! It automatically adjusts and does all the work for you along the way. So by the time you are ready to retire, you have a fully furnished nest egg!

Add in the fact that your retirement savings plan is on autopilot, and you’ve got a very attractive option. Other advantages of target-date funds include:

• Available for different time intervals
• different asset allocations
• Available with different risk profiles
• Actively versus passively managed funds
• Different allocations of
  • Domestic stocks
  • Foreign stocks
  • Bonds
  • And more

So, all around it sounds like a win. It seems like the ideal retirement vehicle, especially for someone with little investment knowledge or experience.

And yet… I still wasn’t convinced. After a couple of years of not thinking at all about my retirement, I went back and took a long, hard look at my target-date fund.

And I was not pleased with what I found.

Lagging the Market

Of course, a set-it-and-forget-it system for your retirement is lovely, but is it really the best investment for your 401(k)? Is it really going to help you achieve your retirement goals in time, or even help you get all the way there? 

Unfortunately, I found that the answer to both of those questions in my case – and probably in the cases for many other people – was a resounding no.

As I started to learn more about the stock market, and followed what the markets were doing more closely, I went back and took a hard look at the target-date fund I was 100% invested in. 

What I discovered was that not only was this actively managed mutual fund not making me oodles of money. But that the equity portion wasn’t even keeping pace with the generic stock market.

In other words, the target-date fund had been underperforming the S&P 500 for most of the past decade prior to my investing. And I didn’t see any signs of a big sudden turnaround. 

I realized that over this time period I would have been better off dumping all of my money in a fund that passively mirrored the S&P 500 index rather than this actively managed fund. 

And this fund was also costing me returns in management and expense fees.

Forget beating the stock market. It wasn’t even keeping pace! So, I did what now seemed like the rational thing to do. 

I ditched my target-date fund and looked for more efficient and productive places to stash my 401(k) money.

Why You Should Ditch Your Target-Date Fund

I think that unfortunately, a lot of people who don’t spend much time contemplating their 401(k) would probably find themselves to be in a similar boat if they looked at their portfolio. 

Now, there are several reasons why a target-date fund may not be earning the kinds of returns over time that you want and need for a comfortable and happy retirement, including:

• The time horizon is off with your retirement
• The fund doesn’t fit your risk profile
• The asset allocations are wrong for your preferences
• Too many management fees and expenses
• The fund is simply underperforming.

Target-date funds might be the right choice for some people in certain financial situations and with certain risk tolerances. But that doesn’t mean they’re right for everyone, or even most people. 

After all, people are living longer than ever and they need their money to last them all through a lengthy retirement. 

For some people, that could be up to 30 years (or more!) of unemployment. As a result, you can’t be as conservative with your investments as people were in past generations.

This is especially true with how low bond yields are these days with no sign that they are going to pick up substantially. 

With money markets and bonds earning virtually nothing in yields, these types of investments are not going to even get close to the types of income you need to sustain you through retirement. 

You need to keep a significant portion – maybe even most of your money – in income-generating dividend stocks and even some growth stocks so you can take advantage of larger capital gains.

What You Should Do Instead

In the end, your target-date fund might be the right investment for you. But, if you had a set-it-and-forget-it approach, I highly recommend that you go back and take a long look at its performance. 

Ask yourself the following questions:

• How has the fund done over time?
• Has the equity portion kept pace or beat the market?
• Does it take on enough risk to earn you the returns you need for your retirement nest egg?
• Are your fees and expenses costing you an arm and a leg?

It is absolutely crucial to keep a strong watch over your nest egg. I encourage you to not be like me with the handyperson when I need a paint job.

Take an active role – this is your future and retirement we’re talking about. You are the best possible steward of your own money. 

If your target-date fund is a loser, I urge you to ditch it. Look for mutual funds that are better suited to your retirement needs.

At the very least, your stocks should keep pace with the market and, ideally, beat them. There are various equity funds that can help you do this, including those that mirror the S&P 500 or focus on riskier but potentially more rewarding investments.

As you age, you can always shift some of your money into more conservative investments. These could include investments like bonds and money market funds when you are ready. But you should still manage this actively.

Nobody will care more about your retirement money than you do. So, take good care of it so you can live your dream retirement when you finally hit that target date.