By Dr. James M. Dahle, WCI Founder
I am often asked about lifecycle mutual funds in general and Vanguard's Target Retirement funds in particular. Readers somehow have gotten the vibe that I hate these funds. I don't hate them, but I also don't use them in my retirement portfolio because they don't work for me. This post will explain why.
What Is a Lifecycle Fund?
A lifecycle fund is a balanced mutual fund, holding both stocks and bonds. It is also a “fund of funds,” meaning its only holdings are other mutual funds. The fund is automatically rebalanced to maintain its desired asset allocation as time goes by. Lifecycle funds follow a specific “glide path,” generally becoming less aggressive as the years go by. Most of the big mutual fund companies offer some type of lifecycle fund, and they are often offered within 401(k)s. In fact, 62% of 401(k) participants use lifecycle funds, and these funds account for 24% of all 401(k) dollars.
The worst lifecycle funds only use actively managed mutual funds that are unlikely to outperform as the years go by, and they also add on a fee in addition to the expense ratios of the underlying funds. My favorite lifecycle funds, the Target Retirement funds at Vanguard and the “L Funds” in the TSP, don't do this. Vanguard also offers the “Life Strategy” funds, which used to contain actively managed funds but now are essentially the same as the Target Retirement funds (except that they maintain the same asset allocation each year rather than becoming less aggressive as time goes on). Lifecycle-style funds are also available in many 529s; they just have a steeper glide path as the student approaches college age.
Pros and Cons of Lifecycle Funds
Advantages of Lifecycle Funds
Lifecycle funds, particularly those from Vanguard and the TSP (and the Fidelity Freedom INDEX Funds but not the older, actively managed Fidelity Freedom Funds), can be great investments. They are low-cost, low-maintenance, and reasonably well-allocated among various asset classes. They provide instant diversification among asset classes and within asset classes. They are a great one-stop mutual fund shopping solution that you can recommend to less sophisticated investors and that can be placed in a 401(k) to alleviate fiduciary liability concerns. Another important advantage of balanced funds is that they are less volatile, so investors are less likely to engage in behavioral errors such as performance chasing and selling low. They're great for someone with a single investing account, such as a Roth IRA. With all these advantages, why don't I use them?
Problem #1: Not Available in All Accounts
We have a complex portfolio because we have four 401(k)s, two Roth IRAs, an HSA, a Defined Benefit Plan, and a taxable account. That doesn't include 529s, UTMAs, and Roth IRAs for the kids. No single lifecycle fund is available in all of these accounts. What is the point of a one-stop mutual fund solution if you have to mix it with other funds? There is none. I could hold lifecycle funds in some accounts, but balanced funds in general and lifecycle funds with their ever-changing asset allocation, in particular, don't mix well with other mutual funds in an asset allocation. Even if you can get to an overall asset allocation you like, rebalancing involves much more complex calculations when you toss in some lifecycle funds.
Problem #2: The Dates Are Misleading
Albert Einstein said, “Make things as simple as possible, but not simpler.” I think lifecycle funds fall into the trap of making things simpler than they should be. The idea of choosing an asset allocation based on just one factor—the date you plan to retire—doesn't necessarily account for your unique ability, need, and desire to take risk. For example, the Vanguard Target Retirement 2045 fund has an asset allocation of 86% equity. In a big bear market, that fund could lose about 45% of its value. Not everyone who plans to retire in 2045 can psychologically handle a 45% drop in their retirement account value without bailing out and selling low, resulting in an investment catastrophe.
To make matters worse, every fund company has a different asset allocation for any given date. For example, Fidelity's Freedom 2030 fund is 63% equity, Vanguard's Target Retirement 2030 fund is 64% equity, and the TSP L 2030 Fund is 60% equity. If you're going to use a lifecycle fund, choose it based on the asset allocation (and change funds depending on your desired asset allocation periodically). If you've got to understand asset allocation anyway, what's the point of a date-based lifecycle fund? The only argument its proponents can really make is, “Well, it's better than lots of stupid asset allocations people come up with either on purpose or on accident.” That's true, but it doesn't take a whole lot of sophistication to come up with your own desired asset allocation and implement it.
Problem #3: I Want a Different Glide Path
I'm a little bit of a control freak and like to be in command of my investments as much as possible. A lifecycle fund changes my asset allocation automatically. Automatic investing can be a great thing, but I prefer to have more control over my asset allocation. For example, we have had basically the same asset allocation for the last 15 years (60% stocks, 20% bonds, 20% real estate). It works for us in both bull and bear markets. We may take less risk as we get older, but to me, it makes a lot more sense to decrease equity allocation after a big run-up in stocks, rather than just doing it automatically at 1% or so per year. A gradual decrease is better than dumping stocks after they've had a bad year or two, but I don't feel like we need to protect ourselves from this behavioral error by using a lifecycle fund.
I frequently find myself wanting to follow a different path than the one traveled by the herd.
Problem #4: I Want a Different Asset Allocation
Did I mention I'm a control freak? I also like to tinker. Vanguard's Target Retirement 2025 Fund holds only three asset classes. Our portfolio used to contain 12. (A few years ago we simplified a bit, and we're now down to nine asset classes.) Do you need 12, or even 9? Of course not. There is little benefit at all to having more than 10, but there are lots of benefits to having more than three. There are huge benefits to simplicity.
I also buy into the idea that “tilting” a portfolio toward asset classes with higher expected returns (like small and value stocks) is likely to result in higher long-term returns. Lifecycle funds don't generally have small value tilts, and they don't include REIT allocations, microcap allocations, alternative asset classes, etc. If you enjoy debating the merits of short-term TIPS vs. intermediate-term TIPS, you're not going to be happy with a lifecycle fund.
Is it possible we'd be better off with a simpler total market-based portfolio? Of course, especially over the last decade. In fact, Mike Piper, a very sophisticated investor, has a Life Strategy fund as his only investment holding. But I'm willing to bet my life savings that I can do better than a lifecycle fund, and so far, I'm winning that bet.
More information here
Problem #5: Lifecycle Providers Chase Performance
Lifecycle fund managers are just as guilty as the rest of us at chasing performance. Just before the 2008 bear market, mutual fund companies seemed to be competing to see who could get a more aggressive asset allocation and glide path into their lifecycle funds. Vanguard recently added international bonds to its target retirement funds. When you buy a lifecycle fund, you're getting some active management in your asset allocation, and like all active management, you may or may not come out ahead because of it. These funds are hardly the stable long-term allocations they market themselves as. Fund companies are also tempted to place their new mutual funds into their lifecycle funds. This gives the new funds “instant assets under management,” making them appear more successful than they would otherwise be.
Problem #6: Taxable Time Bomb
One of the biggest problems with lifecycle funds is that they are inappropriate for taxable accounts because they become increasingly tax-inefficient as the years go by. As a general rule, if part of your portfolio is in retirement accounts and part is in a taxable account, you want to preferentially place tax-efficient asset classes (like stocks) into the taxable account and leave tax-inefficient asset classes (like bonds and REITs) in the tax-protected retirement accounts. This is called asset location, and while it doesn't matter as much as asset allocation, it still matters. If your only holding is a balanced fund, then you're necessarily holding at least one asset class in a suboptimal location. To make matters worse, as you get closer to retirement, a lifecycle fund gets more and more tax-inefficient as the bond allocation increases. Fixing the error becomes more expensive each year as the taxable capital gain in the fund increases. Lifecycle funds also don't contain municipal bonds, which high earners forced to hold bonds in taxable should usually be using.
Problem #7: Lifecycle Funds Are (Usually) More Expensive
Many lifecycle funds add on an additional fee above and beyond the expense ratios of the underlying accounts. Even the providers that don't do this, like Vanguard, may charge more in other ways. Vanguard offers cheaper “Admiral” shares of most of its funds if you have at least $3,000 in the fund. However, the funds held by the Target Retirement funds are NOT the cheaper Admiral shares; they are the more expensive Investor shares. For example, the Vanguard Target Retirement 2030 Fund has an expense ratio of 0.08%. I can build it myself using Admiral shares for cheaper. Now, a few basis points isn't much, I'll admit, and the TSP does NOT charge more for its lifecycle funds. But some fund providers charge dramatically more. Always remember that investing expenses come directly out of your investment return.
Lifecycle funds can be great investing options, especially for investors with small portfolios located entirely within a single retirement account. But they don't work for my retirement portfolio, and there's a good chance they're not the best option for yours either.
What do you think? Do you use a lifecycle or target retirement fund? Why or why not? Comment below!
[This updated post was originally published in 2013.]
I absolutely agree with this post. My group 401K plan is phenomenal–I am essentially matched the entire 17.5K that I put in. Unfortunately, the Fidelity investment options are extremely poor; essentially there are no index fund options available. The Target Date Funds end up being the most appealing option.
It seems like it would be insane to give up the 100% match (and the tax-advantaged benefits of the 401K itself) for better investment options in a taxable account with Vangard, but it’s frustrating nonetheless. I’m going to end up with the headache you describe of trying to rebalance to my desired asset allocation using both my Target Date Fund and several indexed funds.
The other issues I have with these funds is:
1. You cannot optimize asset classes across your tax advantaged/taxable accounts (e.g. put bonds in your Roth, put your large index in taxable)
2. Tax loss harvesting gets a bit more messy since its a fund of funds
3. Make strategic changes easily (like moving toward shorter duration bonds)
But for people who don’t have the know-how to invest and don’t want to learn, but have made the leap from paying someone else a ton of money for active management, these funds are a great starter.
While I generally agree with the gist of your article I do find they serve a purpose for me. Between my wife and myself we have 8 different tax-advantaged accounts (1) my current 403(b) account, (2) my legacy TSP account, (3) my Roth account, (4) my HSA, (5) her current 403(b) account, (6) her legacy 403(b) account, (7) her current profit sharing account, (8) her Roth.
There is no way to reduce the number of different accounts to lower than 8 without doing foolish things like roll low-fee Vanguard accounts into high-fee current 403(b) accounts with my wife’s current employer.
So where do Target Retirement accounts come into our portfolio? I use them for all the current contributions into my Vanguard 403(b) simply so that all current contributions go into our portfolio in an asset allocation that reasonably closely matches our overall asset allocation. It just keeps things simple to dump all current contributions into one single fund and not worry about how it might be distorting our asset allocation over time. With a Vanguard 403(b) plan I have Vanguard Target Retirement funds available to me and there is no cost savings by going with individual funds because Admiral Funds are not available within Vanguard 403(b) and 401(k) accounts. So I am paying EXACTLY the same fees with a Target Retirement fund as I would be by splitting my monthly contribution between several index funds.
I also did the same thing with my wife’s legacy 403(b) account which is also held at Vanguard. Again, no fee advantage by going with individual funds within this account and it just keeps things simpler to monitor to put it all in a single target retirement fund.
For a young worker who is just starting out on the first job and has little or no investments I think they are great. It is a low-cost way to put things on autopilot when you are young. However when most people get to mid-career and marriage their portfolios are so complex that a single Target Retirement fund is not practical or possible. However they do still provide a convenient place to put new contributions and a decent way to invest the odd account without having it distort one’s overall asset allocation.
Hi WCI,
Can you do a column on tilting a typical Boglehead’s portfolio towards small cap, value, international and REIT stocks?
Also have you ever heard of Paul Merriman and his all Vanguard fund recommendations that are mostly small cap, value and international funds?
Thanks.
Sure, there’s nothing wrong with Merriman’s suggested portfolios which can be found here: http://paulmerriman.com/vanguard-tax-deferred-etf-portfolios/
I disagree with you that there is a “typical Boglehead’s portfolio” that is “tilted towards small cap, value, international, and REIT stocks.” Bogleheads have a very wide variety of portfolios, many of which don’t tilt at all. Boglehead principles include wide diversification, buy and hold, and keeping costs low.
However, my own portfolio does tilt toward those asset classes (actually it probably tilts away from international since it is only 1/3 international) and you can read about it here: https://www.whitecoatinvestor.com/evolution-of-the-white-coat-investors-portfolio/
I also recommend Madsinger’s monthly reports on portfolio performance. Here’s the latest: http://www.bogleheads.org/forum/viewtopic.php?f=10&t=127523&newpost=1878240
You’ll notice that a tilted portfolio has performed better than an untilted portfolio if you go back to 1999, but that a simple 3 fund portfolio is outperforming the sliced and diced portfolio year to date.
Great reply. I like Merriman a lot and he has a nice podcast if anyone is interested (in addition to his website and MarketWatch articles)
He does recommend for younger investors with a 20+ year horizon until retirement that one could consider tilting towards small cap, value, REIT, and international to increase your return. This is with the understanding that the money being invested will not be needed for other expenses in the interim, and that the psychologic fear of selling at a loss during a downturn can be abated.
Of note, REITs and small cap value stocks are better off in a tax advantaged account (bonds and REITs first before any higher turnover stock funds), so for me placement in a tax advantaged also prevents me from panicking on these more volatile assets since I don’t want the double hit of a loss and the tax hit of withdrawing from a Roth/40xb plan.
Given our current low interest rates, bonds in tax-protected isn’t necessarily ideal. Many will be better off with munis in taxable. Every individual has to run the numbers unfortunately. I agree that more tax-inefficient stock classes are better off in a tax-protected account than a more tax-efficient stock class. I’m not sure why you would take a “double hit” even if you panicked. Why wouldn’t a panicking investor just trade stocks for fixed income inside the tax-protected account?
Interest rates are low, but they will rise throughout 2014 and likely beyond. Non-muni bonds in tax advantaged space makes the most sense at my income level (and likely your readers), and is in agreement with a lot of what Ive read on the Bogleheads site.
You are right that you can just trade within your tax protected account, when I meant panic I meant pull out of everything but you are absolutely right you could just swap for another class.
But historically, Ive put REITs, non-muni bonds, and higher turnover funds (like small cap value) in my tax advantaged space, while the total stock market and international stocks in my taxable space. I feel over a long-period of time the tax advantages of this outweight putting a less optimized lump of money from a Target Date Fund within each class.
Many Bogleheads are wrong on this point, unfortunately. It isn’t as clear cut as just putting the least tax efficient asset into a tax protected account. Rate of return also matters. Run the numbers yourself and you’ll be convinced.
For example, Total Bond Market Index Fund has a yield of 2.08%. Intermediate term muni fund has a yield of 2.38%. Both are composed of very high quality bonds with a very low risk of default. What is the expected return on these investments? 2.o8% and 2.38% respectively. Even if you buy it in a tax-protected account, you’ll probably come out ahead just buying the muni fund. But let’s just use 2% for your bond return. Let’s use 8% for a stock return. Let’s say you want a 50/50 portfolio and have a $100K Roth and a $100K Taxable account, a 33% marginal tax rate and a 15% capital gains/dividend rate. Which asset do yo put in the Roth and which do you put in the taxable account? You are suggesting the bonds should be in the Roth, no? Let’s see what you end up with using that approach.
After 30 years, the bonds in the Roth have grown to $181,136. The stocks in the taxable account grow at 7.7% due to the effect of taxes. After 30 years, after tax, it grows to $801,847. For a total of $982,983.
If, however, you decide to put the bonds in taxable, and the stocks in the Roth, what will you end up with? Well, if you use taxable bonds with a 2% return taxed at 33%, you’ll end up with $149,083. In the Roth the stocks will grow to $1,006,266, for a total of $1,019,408, over $36K more. If you were smart enough to use muni bonds in that taxable account, it would be over $68K more.
Both the tax-efficiency of the asset and the rate of return matter in deciding which assets to put in taxable accounts in preference to a tax protected account.
If interest rates, and thus the expected return on fixed income, rise, then at a certain point bonds in tax-protected will again make sense.
Hope that helps.
WCI,
Thanks for the links. I will look into them. I am a novice Boglehead with a three fund portfolio and have read a little bit about the “slice and dice” portfolio.
If the data comparing tilted versus untilted goes back to only 1999, what is the logic behind recommending a tilted portfolio?
Thanks.
There’s plenty more data out there, but that just happens to be very convenient, up to date data. I don’t recommend you tilt or not tilt. Either is fine. I tilt, but I only do so mildly. Frankly, that is a very minor factor in whether you become a successful investor or not.
I agree that for you it makes less sense to use the target retirement funds. Personally I like the asset allocation for my goals and I’m pretty much a 3 fund guy anyway (4 if you count the international bonds they have in there now). But also luckily for me my retirement savings are currently all associated with TSP and IRAs so I can pretty much have them all doing the same thing. Meanwhile my taxable savings are to pay for my home when I retire from the military (at which point I will only work part time). I tend to rent since I move frequently and I want to have cash to pay for my eventual retirement home, which will be in 12ish years and I’ll be 49. That money can’t really come from the TSP and IRAs so my taxable savings has a different timeline and goal so it ends up with a different asset allocation as well.
Lately we have actually considered buying and building our retirement home piecemeal. We might buy the lot next year, build a small guest cabin on it to use as a vacation home a few years later and finally build the main home after military retirement. Each stage will only be done if we have the cash to do it at that time.
Sounds like you’re the perfect person to use TR funds.
I’m considering a Vanguard Target fund and I wanted your opinion on my opinions of your opinions listed above. 🙂
This is also kind of in response to https://www.whitecoatinvestor.com/how-i-currently-implement-my-asset-allocation as well. Thanks for being so open so I can learn and come to conclusions for my own internal financial “debates”.
P1 with Accounts: Since I’m a beginner (aka intern, just like when you started this investing adventure) this is not been a problem for me yet and from reading your blog I’ve noted that 401ks often offer Target funds but NOT other index options.
P2 with Dates: I don’t see the issue here. I just need to decide the year in which I want my retirement to tip towards conservative (50% equity / 50% fixed income at the year in the name). With your plan, you have to decide the same thing but you have to manage the glide.
P3 with Glide: You seem to indicate you will try to “time” your glide. Isn’t that why indexing and rebalancing concepts were created to avoid timing the market? Won’t you be tempted to wait starting your glide if your retirement comes at the same time as a bubble? If you plan a glide and stick it to it you should be fine but it sounds like you haven’t set it in stone just yet.
P4 with Allocation: Though I understand the concept of diversification, I don’t fully comprehend this concept of tilting. To me, it feels like tinkering, bordering on guessing the market. Surely when I invest in the Total Stock Market I am investing in the small cap as well. I understand that the Total Stock Market could be deemed “tilted” towards large cap but isn’t that just the reality of the full market that has more stable returns? Basically you stated you would be okay financially if these riskier allocations relatively flopped but your gambling for a few extra percentage points on your ROI. Is that a fair statement? Call me conservative but I want to get “rich” slow and steady.
P5 with Managers: This problem makes sense to me. Managed indexing does seem like an oxymoron, but I don’t think the managers will get many investors if they do more than balance and follow the plan proposed. Your critique of adding international bonds falls a little flat when your own investment plan has ballooned to include new allocations as you become more well read. If a Target Fund ever announced a major change that profited the company providing the fund, I would jump ship so quick they wouldn’t get a cent.
P6 with Tax Efficiency: Since this is not a problem for you, I doubt it will be a problem for me. You posted that even you (with your wise savings) were not able to maximize your tax havens and had no taxable investment accounts. I’m still trying to wrap my mind around the $50k 401k but I will look for this possibility during my job searches on its own merits.
P7 with Costs: This is the one where you really could change my mind. But then I saw your “usually” hiding behind parentheses so I did some research. Vanguard Target fund expense ratios are 0.18%. You have a lot to be proud of by setting up a plan with 0.16%. Are you sure you haven’t made 2 base points worth of errors? How about your delay in rebalancing in comparison to the funds continual rebalancing? Or a slight delay in investment do to complications or adjustments necessary with 5 accounts? Granted you are probably really on top of these things but the average doc is likely to make some costly error/delay along their ‘investing career’ (including me). Plus you said this takes 2 hours per year (not to mention this website management’s countless hours of self-education) to make investment decisions. If you spent that time working as ED doc (as stressful as it is) you will probably negate most of the reward of your own “targeting”.
Basically I’m intrigued by cheap Target funds because it takes the #1 danger (ME) out the equation in two more ways (indexing already removing my guessing the market):
1) Rebalancing
2) Gliding
In conclusion, educate me. I have lots to learn and thanks to your website I have a good start.
Found your comment in the spam section. Thanks for the email. It’s easy enough to fish them out of there, if I know about what time you wrote them. However, between the time you wrote your comment and the time I read your email I had 13 pages of spam comments.
I don’t think you need nearly as much education as you claim. I think you understand the pluses and minuses of using a target retirement fund quite well. If you’re not interested in a tilt (and there are good, sound, logical reasons to lean either way in this particular debate), then it’s an even better option.
You are absolutely correct that the biggest enemy an investor faces stares at him in the mirror each morning.
Wow, you really have some great points…I think Target Funds are for me!
I’m an old investor, but I pretty much agree with your rebuttal points.
P1. My 401K has Vanguard’s target date funds. That’s one account I really never need to be concerned about. It can run on autopilot for years. It may not be a ‘one-stop’ solution, but it is an ‘N-4′ solution (reduces my complexity by four funds).
P2. I’ve never once been mislead by the fund years. I’m doubtful anybody reading the White Coast Investor blog would be mislead. I’ve always failed to see the difficulty of checking the asset allocation and picking the one that matches their needs the best. Names are created by marketing folks, it’s what’s inside that matters.
P3. The glide paths seem pretty reasonable, but if I want to change it, it’s really easy to swap funds. To balance my allocation with the rest of my accounts, as I got closer to retirement, I recently moved from the 2045 to the 2025 fund. Took four mouse clicks. Not exactly difficult to do. Actually, to fine tune I mixed in a some Target Date Income to pick up more TIPS. Somebody at Vanguard may have went into shock from my mixing and matching, but their desires don’t effect me any more than the Mercedes salesman’s desires for my money…
P4. Funny, my being a control freak is one of the greatest advantages to a target date fund. My 401K is one account is a core account I don’t need to tinker with much. It’s also my reference and benchmark for how I’m doing with the other accounts. Each time I want to change something, I first look at what Vanguard would have done and ask “what superior knowledge do I have that they don’t”? A lot of time I back off from making changes because I’m not really sure I’m right. Also, my 401K doesn’t have any of those ’tilting’ funds, so not a choice there.
P5. Hm, I seem to have made a few changes to my portfolio allocation since 2008 too… Real estate anyone? Vanguard’s changes seem fairly modest. Increased international equity a little and added some international bonds. Hardly worth all the anguish generated on Bogleheads. Unless it disagreed with someone’s perfect crystal ball, of course… Hard to see adding international bonds as ‘chasing performance’. Have they ever made a profit? After inflation? The theory that international equity may do better going forward due to their lower price recently doesn’t seem completely crazy. If it causes heartburn, just sell a little international stock in another account. Excel doesn’t have any problem figuring the adjustment.
P6. Tax Time Bomb — isn’t that the same hyperbole the radio ‘never again lose money in a market downturn’ guy uses? I assumed he’s an insurance salesman. With bond yields so low, that taxable time bomb may be more like a tax firecracker, or maybe ladyfinger… But then I’ve never considered or looked at a Target Date fund in a taxable account. My 401K is my largest account, so I’m probably never going to be 100% bonds there. Slowly shifting to a higher percentage to the Target Income fund should work for a long time.
So no, Target Date Funds are not perfect, but then neither is anything else on Earth. They are a reasonably good allocation and can prove useful, especially in accounts with limited choices, like many 401K’s. Just because a provider recommends one and doesn’t want people to mix with other funds in no way inhibits an ability or desire to do so.
I enjoyed reading the post on Lifecycle funds, and though I generally agree with it, I find myself in a difficult situation. I’d certainly appreciate your input.
So it goes like this. As a federal employee, I have my TSP; I contribute to the 5% match, I have a reasonable 75/25% stock to bond ratio, and it’s done pretty well. I may check on it a few times a year, but otherwise I pretend it doesn’t exist.
As a moonlighter, I have 1099 income, so this is where it gets more interesting. I’ve been contributing the max to my Roth IRA since I was a resident, and I’ve kept that going via the backdoor Roth as an attending. I’ve also been contributing to an individual 401K, both traditional and Roth for the past 2 years I’ve been an attending (also rolled over a SEP IRA from when I was moonlighting as a resident…I figured out the aggregation rule thing, though my financial guy should have been the one to figure it out, but that’s another story).
I’ve been educating myself on investing for the past few months, and came up with a reasonable asset allocation. I fired my financial guy, and moved all my assets to vanguard (Roth IRA, and Roth/Trad 401K). I already knew that there was no brokerage option or admiral shares for individual 401Ks from what I read on this site, but I figured it would be easier to have everything under one roof.
When deciding which funds to place in which accounts, it started getting difficult. I wanted to put certain funds that are more expensive (e.g. International Small Cap) into my Roth IRA, since I can use an ETF (or admiral shares for other funds). The cheaper funds were the Total Market Index, Total International Stock Index, and Bond Market Index (expense ratios of 0.17, 0.22, 0.20), so I thought I’d put those into the 401K. Then I noticed that the LifeStrategy Growth fund also has these funds (and an international bond fund which I don’t particularly care about), with an overall expense ratio of 0.17%. So technically, it’s cheaper and ‘simpler’ that buying the funds separately, though the asset allocation is not quite what I want (but not bad).
So I’ve had a few different ideas about it (let me know if any are crazy). I’ve tried bouncing these ideas off of some friends, but they just look at me funny and have no idea what I’m talking about.
1) I could buy the LifeStrategy Growth fund in both my traditional and Roth 401K, and keep buying more with new contributions until I decide to change it to something less aggressive in the future (could also do a target retirement fund). But basically treat it like my TSP and not count it for anything. And implement my asset allocation (which is small cap and value tilted) just in my Roth IRA and a brokerage account.
-pros: it makes asset allocation easier, I get lower expense ratios, and at least some of my money is protected from my doing something dumb
-cons: potentially less gains over time, I can’t put as much in my Roth IRA as I can in a 401K, so less money to work with, but I can put significant amounts into a taxable brokerage account (what the hell else can I do with it other than put it under my mattress, I’ve already maxed out my tax advantaged accounts).
2) I could buy the LifeStrategy Funds as per number 1, but count them toward my overall asset allocation, and buy the rest of the funds in my ROTH IRA and brokerage account. I’d have to bust out my TI-83, and drink lots of coffee, but it could be done.
-pros: still get the lower expense ratio in my 401K , more money involved using my preferred asset allocation
-cons: lots of math at the start, lots of math rebalancing each year, and potentially lose all my money because I forgot to carry the one
3) Just suck it up, forget about the few basis points of difference between the LifeStrategy Growth fund and each of the individual funds. And just implement my asset allocation like I had originally planned. Do the best I can with admiral shares/ETFs in my Roth IRA and brokerage account.
-pros: preferred allocation, potentially higher returns
-cons: it could have been slightly cheaper, still some balancing issues across 4 accounts
I swear that ignorance is bliss. But since that’s not an option, here we are. I hope that ETFs or admiral shares are offered for 401Ks at Vanguard in the future, it would make all this easier. Maybe I shouldn’t worry so much, I have a really good savings rate, so odds are it’ll work out either way. Regardless, wondered what you thought about it. I’m sure a few others may come across this situation.
Oh, I’d like like to say one good thing about whole life insurance. If it hadn’t been for a ‘friend’ trying to sell me whole life insurance when I was an intern (6 years ago now), I would never have started reading about personal finance. Fortunately, I found out what a bad idea it was and said ‘no’. Then someone else tried selling me indexed universal life insurance earlier this year; and that got me interested in investing and led me to this website. Anyway, there’s nothing like the feeling that someone is trying to take advantage of you to get you motivated and informed. So my hat’s off to terrible insurance products that don’t fit my needs….
I do # 3, so I guess that’s what I ought to tell you to do. You’re right that you shouldn’t worry so much, you’re doing fine and you understand all the issues and trade-offs involved with this relatively minor decision. Many, many docs find this site while researching recommended cash value insurance products. I don’t think the agents who post in the comments section to argue understand they’re just moving the page up the Google rankings (and making it easier to find) every time they post a comment.
Just thinking about my 401K as I read this post. WCI briefly discussed rebalancing above, and it got me thinking about how I would rebalance after a very large fall in stock prices. I know it’s an older post, but I’m hoping WCI gives his thoughts.
In my 401K, I have a model (I can choose from “models” such as aggressive, moderate, income, etc.) and various other funds that I invest in to get me to the stock/bond allocations that I want (my 401k does have access to Vanguard total stock index, a few other Vanguard index funds, some decent [not junk bond] bond funds like a total bond index, etc.)
I am questioning what I would do after a large sell off in stocks in order to rebalance my 401K given that I have minor investments in individual funds within my 401K and am heavily invested in one of my 401K models (which has its own percentage of stocks to bonds). I’m not sure how I would even go about rebalancing within my 401K after a large stock correction given that I am limited each year as to how much I can contribute to my 401k. I feel that being so heavily invested in this model would limit my ability to sell off a portion of my bonds in order to purchase stock index funds to return me to my given stock/bond preference. In effect this would prevent me from buying stocks at a discount through rebalancing. I may want to get out of the “model” fund in my 401K sooner rather than later–what are your thoughts? Do target date funds face a similar issue as my “model” fund, or would they rebalance appropriately after a market crash?
Your model fund is probably like a target retirement fund and sells bonds to buy stocks in a market downturn automatically. Read the fine print to be sure, but that’s probably the way it works.
Thanks for writing this blog & educating all of us! Your response (copied below) to one of the comments made me remember why I paid a financial advisor for so long. I’d like to know if you calculated the numbers in your response with the help of a calculator or program or if you did them out longhand the old-fashioned way. If there’s a program that you use to run scenarios & calculate these numbers I’d love to know what it is! It would help smooth out some of the work involved with DIY financial planning 🙂
Many Bogleheads are wrong on this point, unfortunately. It isn’t as clear cut as just putting the least tax efficient asset into a tax protected account. Rate of return also matters. Run the numbers yourself and you’ll be convinced.
For example, Total Bond Market Index Fund has a yield of 2.08%. Intermediate term muni fund has a yield of 2.38%. Both are composed of very high quality bonds with a very low risk of default. What is the expected return on these investments? 2.o8% and 2.38% respectively. Even if you buy it in a tax-protected account, you’ll probably come out ahead just buying the muni fund. But let’s just use 2% for your bond return. Let’s use 8% for a stock return. Let’s say you want a 50/50 portfolio and have a $100K Roth and a $100K Taxable account, a 33% marginal tax rate and a 15% capital gains/dividend rate. Which asset do yo put in the Roth and which do you put in the taxable account? You are suggesting the bonds should be in the Roth, no? Let’s see what you end up with using that approach.
After 30 years, the bonds in the Roth have grown to $181,136. The stocks in the taxable account grow at 7.7% due to the effect of taxes. After 30 years, after tax, it grows to $801,847. For a total of $982,983.
If, however, you decide to put the bonds in taxable, and the stocks in the Roth, what will you end up with? Well, if you use taxable bonds with a 2% return taxed at 33%, you’ll end up with $149,083. In the Roth the stocks will grow to $1,006,266, for a total of $1,019,408, over $36K more. If you were smart enough to use muni bonds in that taxable account, it would be over $68K more.
Both the tax-efficiency of the asset and the rate of return matter in deciding which assets to put in taxable accounts in preference to a tax protected account.
If interest rates, and thus the expected return on fixed income, rise, then at a certain point bonds in tax-protected will again make sense.
Hope that helps.
I use the Future Value, Rate, Period, and Term functions in Excel or Google sheets. But you could buy a financial calculator too. Hiring a financial advisor just to do calculations like these for you is a very expensive calculator.
What is your opinion about using target date funds for non-retirement purposes? For instance, if someone wanted to buy a home in 10 years or send their child to college in 15, then (counting from today, 2021) they could save up in a Target Date 2030 fund or 2035 fund. I feel like it might be a middle ground for all the folks who want to save money for an expense in the future but don’t want to lose out to inflation in the meantime. Too risky? Thoughts?
Remember even the Target Income fund is still something like 30% stocks and 70% bonds and less than 1% cash. It’s doesn’t turn to cash after 15 years. So it’s fine to use a TR fund as long as it matches your desired asset allocation. When it no longer does, you need to change.
529s have similar funds by their glide path is steeper. I’d use those to save for education. For a house in 10 years, what I use would depend on how exact the date was when I wanted to buy. If very exact, I wouldn’t take much risk. If not, I might put it all in equities at least for the first 5-8 years.
More info on short term investing here: https://www.whitecoatinvestor.com/short-term-investing/
This is the closest I’ve seen you come to timing the market.
“We may take less risk as we get older, but to me, it makes a lot more sense to decrease equity allocation after a big run-up in stocks, rather than just doing it automatically at 1% or so per year.”
Subtle but seems to be slightly contrary to written investment plan unless your plan says cash out after a big run up in stocks. Lots of great plans but my plan after reading a lot is my bond percent equals my age minus 25 which I guess is a glide path so I will have 100% bond at age 125.
Truth be told, never put a draw down plan in our written investment plan. I guess that’s why we’ve basically had the same asset allocation for the last 17 years. I suppose I should add one eventually. Nothing wrong with writing in there “Reduce asset allocation from 60% stock to 50% stock the first time stocks go up three years in a row after I turn 55” or something.
My biggest issue with both Vanguard’s Target Retirement and Lifestrategy funds is the high international allocation, which continues to gradually increase as time passes. Years back I think the international percentage was half of what it is now. Does Vanguard provide any justification for doing this? I assume it’s because of international stocks’ underperformance relative to US over the last 10+ years.
I think it’s only been changed once (to a higher international allocation), but I could be wrong. At any rate, if you care whether your international allocation is 20% or 33% of equity, a target retirement fund isn’t for you.
Isn’t it a good thing? Your standard market cap weighted fund buys companies that grow larger and sells companies that have grown smaller. Shouldn’t the same standard be applied to countries also?
I don’t know if it is a good thing or not. It just is. The last few years it has been bad thing as the US has outpaced international. The next decade maybe the pendulum swings the other way.
For most of my life I’ve felt like I was usually the smartest guy in the room, I know that’s terrible. Add to that my perverse desire to quibble with posts, also terrible. But Dr. D, there simply isn’t any way for this chemical engineer to feel smart or to find something to quibble about in your posts. Fact based, impeccably presented logic every time!
Thanks for your kind words. It’s a pleasure to serve.
Thankfully my IRA, 401(k) and HSA all allow me to use Vanguard funds. I enjoy the simplicity of the Target Date funds so I think I’ll stick with them. I see how they don’t make sense for you though.
That’s great, but I bet you’re fairly rare in having it available in all your accounts. Might as well take advantage I suppose.
My work has a nice 401K that uses Vanguard funds with target dates. I don’t have a beef with Vanguard funds personally just because even if the market dipped 50% and I’m retiring a couple decades from now I’m not too concerned at all.
I keep my retirement funds fairly simple (maybe “too” simple) and then my non-retirement funds is where I take a lot more risks.
Basically, half my portfolio is classic bogleheads investing, and the other half is, really ‘degenerate gambling.’
But I can see if you wanted to do a bit more with your investments why target retirement funds might not be a great fit for you.
Thanks for another great article.
The points you make are relevant to a large number of your readers, no doubt.
However, I imagine that these points are not relevant for many others.
You could just have easily written an article about the benefits of target date funds for some. In fact, I challenge you to do so! 😉
I have 5 retirement accounts, and one of them is about half Vanguard 2040 target date fund. Also, my true retirement date is probably more like 2030, so I picked the 2040 intentionally to be more aggressive. Probably the only bonds I hold are in that 2040 fund, in an otherwise aggressive portfolio consisting of various other Vanguard index funds, REITs, and some individual holdings (water and biotech).
Thanks again.
There’s another one on the site about the Pros and Cons of target date funds:
https://www.whitecoatinvestor.com/pros-and-cons-of-target-date-funds/
Newbie to investing. I have old retirement accounts from previous jobs before med school. I invested in a Target Date Retirement fund — which has done well – It’s now worth almost double (95% return) of what I originally put in there. I know we should avoid trying to time the market – but seems like it can only go down from here. Wondering if it’s better to leave as it is (stay the course) OR sell now. Do Target Date retirement funds give better returns than 95% of your initial investment?
Welcome to the joys of compound interest! Yes, if you own investments long enough, they double in value. That does not mean they’re going to go down in value. It doesn’t mean they won’t, of course either. Best to stay the course so long as your plan is reasonable (and yours is.)
I think you would find reading these Bogle quotes beneficial:
https://financinglife.org/bogle-quotes/