What’s a target date fund?

For many decades, financial advisors, have suggested that as we age, we should reduce our risk. This is achieved by reducing (in a percentage basis) the amount of stocks we own, and increasing the amount of bonds we own.

Until no too long ago, this has been a manual process. The investor (or financial advisor) would sell some of the stocks and buy some more funds.

A typical portfolio rule of thumb is that investors should hold a percentage of stocks equal to 100 minus their age. So a person who is 50 years old should hold 50% stocks and 50% bonds. When that person turns 60 years old, that person would hold 60% in bond and 40% in stocks.

A target date makes the whole process automatic.

Instead of the investor selling some stocks and buying some more bonds at the end of each year, the target date fond does that all by itself.

Another advantage of target funds is that the cost is much lower than if you have a financial advisor doing the work for you. Vanguard is the low cost leader and the cost of holding a target date fund is about 0.2%

Are target-date funds a good investment?

In my opinion, they are not a great investment, but they are not a bad investment either. It better than nothing, but you are leaving a lot of money on the table and it’s not providing the extra security it promises.

Let’s look at the Vanguard 2040 target date fund vs. the S&P 500. The volatility is very similar, yet the returns are very different. In 5 years the S&P 500 has outperformed the target date fund by about 100%. This is huge. Yet, at times when investor needed the extra stability, the stability wan’t there.

The outperformance of the S&P 500 is NOT a one-time thing. In practically every 10 years + period, the broad-based index will outperform the target date fund.

The reason? The reason is that historically, stocks have outperformed bonds. There are very few periods in history, when that has not been the case. The longer you hold stocks, the more you can be certain that they will out perform.

The Warren Buffet solution

Warren Buffet suggests putting 90% of the money in stocks and 10% of it in bonds.

The idea is that if a person is the retirement phase of their live, to withdraw from the cash until the market recuperates.

His strategy has been backtested through many periods in history and it has always come out as a great investment strategy.

The FIRE solutions

Many proponents of the fire movement ( Fritz Gibert, Steve Adcock, etc… ) suggest that we should have 100 % of the money invested in stocks and 3 years worth annual expenses in cash. So, at the end of the day, it doesn’t depend on the percentage stocks vs. bonds, but on the annual spending rate.

Ideally, on a bull market, you would withdraw from stocks and dividends, and on a bear market, the individual will withdraw from the cash stash.

My own portfolio

In the past, my portfolio consisted of 50% real estate and 50% stocks, with an emergency fund of about 3 months of expenses.

At this moment, I hold 75% stocks and 25% real estate.

As I am planning to sell my only rental property, I will have all my money in stocks, but I will follow the path of the FIRE community and little by little, I will build a 3 year emergency fund.

Do you like target-date funds?

Of course, these are my views. I wonder how do you manage risk? Would you invest in target-date funds? Would you do the Warren Buffet portfolio? or would you follow the FIRE portfolio?

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