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Are you planning to retire someday? Unless you are already retired the answer is almost certainly “Yes.” It’s the American Dream!
Of course, there’s nothing magical about age 65. Some people end their careers earlier and busy themselves in different ways. Others enjoy their work so much they keep on going as long as their health allows.
In either case, you probably have some idea when you’ll want to retire. And you probably consider it when planning your investment strategy — or at least you should. That’s because there’s a big difference between age 25 and age 60 when it comes to deciding what to do with your money.
ETF sponsors know this. They also know many people are looking for an “easy answer” that will let them save for retirement without having to think very much. Their solution: Target-date ETFs.
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| Your age governs your investment strategy. |
What’s Your Target Date?
For example, suppose you’re 40 years old. You’re in good health and live carefully. You like your work and think you can keep doing it until you are 70. That’s 30 years from now — year 2040.
With that many years to go, you can afford to be a little more aggressive now. When you get to 60+, you should probably pull back on your risk a bit.
Target-date ETFs automatically do this for you …
For instance in the above case, you might take a look at iShares S&P Target Date 2040 Index Fund (TZV). This ETF buys other iShares ETFs. The proportions are weighted to be more growth-oriented now, and will gradually change to be more conservative as the year 2040 gets closer.
Currently, TZV is allocated like this:
Source: iShares
As you can see in the above chart, the portfolio is invested almost completely in stocks — roughly 90 percent. This is what most advisors would probably recommend for someone with a 30-year time horizon.
The allocation won’t stay this way. As time passes, you will see less of TZV devoted to stocks and more going into bonds …
- In ten years, it should look much like the Target 2030 ETF (TZL) does today, with around 80 percent in stocks.
- In twenty years, it will look like the Target 2020 ETF (TZG) now, with about two-thirds in stocks and the rest in bonds.
- And in thirty years, it should look a lot like the 2010 fund (TZD) does now, with over half the portfolio in bonds.
iShares has a whole series of ETFs keyed to specific retirement years. Other firms offer similar products. They vary in the details of the asset allocation strategy and how it is applied, but the general idea is the same.
So What’s the Problem?
Target-date ETFs offer one-stop shopping with no need to make adjustments along the way. But I’m skeptical for five reasons …
First, their advantage is based on the assumption you will buy and hold them for many years. My experience tells me that very few people will actually do this. Investors get scared in bear markets and greedy in bull markets. They don’t just sit still like the “professionals” tell them.
Circumstances can change, too. For instance, you may decide to retire earlier than anticipated, or later. Then what? You spent decades paying for someone to implement a strategy you end up not even needing.
Second, the target-date strategy isn’t free. In fact you’re adding an extra layer of fees when you buy one of these funds. You pay once for someone to decide what ETFs to allocate your money into, and again for the ETFs they decide to buy.
Is the fee very much? In some ways, no. TZV charges 0.25 percent on top of the component ETF fees. Part of this is being waived right now, but the numbers add up over time. It could be thousands of dollars if you stick with TZV for as many years as they want you to.
Third, each fund family treats the target date differently. This means the stock and bond allocations will often be dramatically different between two funds with the same target date.
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| My guess is that you’re the kind of investor who pays attention to what’s going on in the markets. |
Many of these funds that were at or near their “target date” still got clobbered in the recent bear market. The reason is that many took on more risk in an attempt to look favorable when compared to funds with similar target dates.
Fourth, you probably don’t need them. The fact that you read Money and Markets tells me you want to educate yourself about investments. Chances are you can decide for yourself how to split your money between the different categories of stocks and bonds.
Fifth, investors like you are not the intended market for target-date funds. They are designed for people who don’t pay attention — folks who would otherwise keep all of their money in a low-yielding bank account.
But since you do pay attention, you can do a lot better! So it might not make sense to pay extra for something you don’t need.
Best wishes,
Ron
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