This post originally appeared on The DIV-Net. My company pension fund has the option of investing in something called a Target Date Retirement Funds. Here is how investopedia defines these types of funds:
A mutual fund in the hybrid category that automatically resets the asset mix (stocks, bonds, cash equivalents) in its portfolio according to a selected time frame that is appropriate for a particular investor. A target-date fund is similar to a life-cycle fund except that a target-date fund is structured to address some date in the future, such as retirement.
These funds are obviously catering to the “one size fits all” crowd – that group of investors who want as little as possible to do with their investment planning and will leave those decisions to their pension company. In my particular, the target-date funds I have access to have taken the target-date concept one step further and provided a guarantee on the value of the fund. Here is how it is described in the fund documentation:
The potential for capital appreciation is combined with protection from downside market risk through a guaranteed value at maturity. If held to maturity, the investor will receive the highest month-end unit value achieved over the life of the fund, as guaranteed by ABN AMRO Bank N.V.
So, I pick the fund with the date closest to my expected retirement date, and I will be guaranteed the highest month-end unit value. If the highest month-end value of that fund hits $15 in January 2025 but when I retire the fund has dropped to $10, then I am guaranteed to receive the $15. Sounds like not a bad deal.
What is the catch? Typically, the fees on these types of accounts kill any benefit the guarantee provides. You forgo future returns of the stock market by paying out a high percentage of your portfolio in fees. However, in my pension plan these fees are not too bad but are still substantially more than than some other choices. For example, the U.S. Index Fund option has a MER of 0.06 (which is super low). The 2035 target-date fund has an MER or 0.14%. Again, not much but the difference between 0.06 and 0.14 is actually huge. I did a quick calculation over at SmartMoney on the different on a $10,000 investment and the difference is $586. That does not sound like much but on a portfolio of $500,000 that equates to fees of just under $30,000. That is a substantial amount of money, especially when you factor in inflation.
I am an active passive investor in my personal portfolio, so there is certainly some draw to using a fund such as this in my pension. I consider this money to make up a big portion of my future retirement funds and want to ensure I maximize the risk / return balance. In markets like this it makes sense (the current funds are under the guaranteed value) but how would it work in an up market? That is something I will need to further investigate. As such, I am going to continue researching these funds However, I would love to hear what others think about these funds. Use the comments and let me know!
As you mentioned, a big part of whether or not target retirement funds make sense comes down to whether they charge an extra layer of expenses.
Vanguard’s target retirement funds don’t charge expenses beyond those charged by the underlying funds. So because of that and the fact that the 2050 fund has very nearly my ideal asset allocation, they’re a perfect fit for me. (Granted, I’m also all the way at the extreme end of the passive investing spectrum. The more I can automate, the better.)
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Actually there is a way to balance your stock/fixed income allocation in a way that you cannot lose your principal when you retire.
I don’t like these at all. I think it is a really over simplified concept. You can buy the funds that these fund of funds own directly, so I don’t see why I should pay someone else to do that.
I wrote about this a few months ago:
There’s so many of these, that I’d be worried the fund itself would be gone by the time you retire. Between the different funds’ competition for your money, and as other have commented, the relative ease with which you can change your own asset allocation I wonder about the value add. Just, say once a year, shift to slightly less risk/more fixed income securities.
I think you’re crazy. Any way you slice it, a 0.08% difference in MER is negligible. You could be investing for 50 years and still lose less than 4% of your assets to fees. In the stock market, you could easily lose this much in any given week, and gain it back the next week. Many mutual funds would take this much in under two years!
You’ll lose a hell of a lot more than that just by keeping 20% of your portfolio in fixed-income investments.