[Editor's Note: This is my favorite kind of guest post. If I could get enough posts like this I'd quit writing myself. I solicit these all the time, but rarely get them. This is written by a regular WCI reader, well-researched, and well-written. Joshua Lerner, MD, is an emergency physician and a blogger, although he blogs about his dog and photography rather than personal finance and investing. We have no financial relationship. Enjoy the post and leave a comment with your thoughts.]
I work for a small private physician group and when setting up my 401K I was faced with the choice of either attempting to construct my own portfolio from a list of two dozen mostly actively managed funds or choose a target retirement fund from the mutual fund company. At her hospital, my wife was faced with the same options from a different fund company. So what is a Target Retirement Fund and how do you compare one company’s funds against another? Simply put a Target Retirement Fund is a fund of other mutual funds set on autopilot (from the employee’s perspective) to automatically rebalance and shift its holdings over time into and beyond retirement. Every large mutual fund company has created this type of fund. In reality, most companies actively manage their Target Retirement Funds.
I’m not here to necessarily discuss the merits of these plans. White Coat Investor has already done that. I’m here to talk about how one evaluates the differences between these plans. Though they may specify the same target retirement date, how each company gets you to that date differs. Differences in the relative amounts of stocks, bonds and cash mean differences in returns and risks. Not all plans are created the same.
Glide Paths
To begin, we need to discuss the so-called glide path of a Target Retirement Fund. While funds themselves admit they are subject to change or and may deviate from this path, the glide path is an illustration of the fund’s holdings as one approaches retirement and beyond. Some companies are very upfront about their glide path. Vanguard, for example, has a very simple slider on their website demonstrating the changes in the various holdings leading up until retirement. They also should be commended for keeping the fund itself relatively simple with only a handful of total funds held. Fidelity, T. Rowe Price, and Charles Schwab (the other companies I will review) provide a slightly more vague graph.
As these glide paths can be more vague, and unlike Vanguard, many of these other companies have literally dozens of holdings, making a comparison is difficult. To compare Target Retirement Funds between different fund companies, I took a unique approach. Based on my age, my Target Retirement Date Fund is 2045 (though I hope to retire sooner). Working backwards, if I were ten years older, my Target Retirement Fund would be 2035. The holdings in this fund should be similar to what the holdings in the 2045 fund are ten years from now. Similarly, if I were 10 years from retirement, the holdings should be similar to what the current 2025 fund has as people with the 2025 fund are approximately 10 years from retirement now. The 2015 fund is therefore representative of the holdings at retirement and the 2010 fund is representative of 5 years post retirement. Instead of looking at what each company claims to do in the future, I looked at what they currently are doing now for other individuals closer to or at retirement. As I said before, not all companies have a similar view or strategy.
All data is based on Morningstar.com’s profile of each plan as of 9/23/14.
I’ve simplified this into a graph showing how each company’s funds “glide” into retirement:
Stocks
Looking first at stock holdings (blue on the graph), all four companies start very similarly with total stock holdings between 87% and 89%. The ratio of domestic stock to international stock also has little variability with Schwab holding 5% more domestic stock than any other company. Beginning with the “ten years forward” however, significant variations begin to occur. Fidelity does not change its stock holdings at all while the other plans drop 4% to 9% causing a gap of up to 7% in amount of stock holdings between Fidelity and Schwab.
As one approaches retirement, the gap between holdings narrows. 10 years before retirement, the variability is only 5% with Schwab still the most conservative with 66% stock holdings and T. Rowe price the most aggressive with about 72% (Fidelity has 71%)
Retirement is obviously a crucial time as this represents the point at which the fund must switch from a goal of accumulation to a goal of preservation. It is interesting that the variability at retirement is therefore so broad between the companies and perhaps provides insight into how each company plans to manage itself in retirement. Charles Schwab continues to stay conservative, dropping its stock holdings to 43% while every other company stays at or above 50%. T. Rowe Price stays the most aggressive holding 56% stock at retirement.
Beyond retirement, T. Rowe Price takes a large nosedive, shrinking its stock holdings to 37%, on par with Vanguard and Schwab. Fidelity, on the other hand, maintains nearly 50% stock holdings 5 years beyond retirement.
Bonds
Similar to stocks, bonds (green on the graph) all start off around the same in terms of total holdings among the different companies – between 7% and 9%. Schwab and Vanguard however, quickly shift more holdings to bonds than the other companies with 30% bond holdings ten years before retirement and then more than 40% at retirement and more than 50% after retirement. Fidelity consistently holds the fewest bonds as it clearly seeks to derive growth and preservation from its stock holdings.
Cash
Fidelity diverges from the other companies in terms of its cash holdings (yellow on the graph) at retirement, perhaps to hedge against its otherwise larger stock amount. At retirement Fidelity holds 9.5% of its fund in cash, upping itself to nearly 12% beyond retirement. No other company holds even 6% cash at retirement and only Schwab hits 6.3% beyond retirement. Vanguard consistently holds the least amount of cash through its glide path with T. Rowe Price with the second least.
Summary
Each company takes a different view of how investors should manage their assets into and beyond retirement. Based on the larger stock holdings coupled with larger cash holdings, it appears that Fidelity plans to use cash as a buffer against a down stock market through retirement while the other three companies rely more heavily on bonds as a buffer against a bear stock market. Vanguard and T. Rowe Price are quite similar but Vanguard manages to build a fund with 4-5 holdings while T. Rowe Price has 19. Some Fidelity funds have over 20 holdings, and the utility or benefit of a holding comprising less than 1% of the total fund is suspect.
Vanguard, especially in the years well before retirement, consistently keeps more of your money “in play” and out of cash reserves. This may cause more marked fluctuations in both positive and negative returns but you probably don't want to pay a company to keep your money under a mattress anyway. Why the other companies keep 3% of their funds in short term cash 20-30 years before retirement is beyond me. It may have something to do with flexibility – allowing them to buy into other funds if they desire.
Not surprisingly, Vanguard wins hands down in terms of overall expense ratios (ER). Vanguard ERs range from 0.16% to 0.18%. The Fidelity ERs are four times higher, ranging from 0.61% to 0.78%. T. Rowe Price (0.62%=0.76%) and Schwab (0.52% to 0.8%) are in a similar range. Just remember if you have $1,000,000 in your retirement account, a 0.5% difference in expense ratio adds up to $5,000 per year.
All in all, it is important to understand how your mutual fund company handles your target retirement date fund because you may find your own tolerance to volatility (in relation to stocks in particular) is different from that of the fund company who designed it. Target retirement funds are marketed as a forget-about-it fund (Fidelity even calls them “Freedom Funds”) but before you leave it in the hands of someone else, it’s important to understand how they view the future and your retirement. Like anything else, it’s always crucial to look under the hood and know just what you’re buying!
What do you think? Are Target Retirement Funds available in your retirement accounts? Do you use them? If so, which ones? If not, why not? Were you surprised to see such marked differences between the various mutual fund companies? Comment below!
Nice summary. I’m actually impressed there isn’t more variability between the various companies. I guess they have to keep up with the Joneses in terms of returns.
It’s also surprising how aggressive the stock percentages are. 70% stock 10 years out from retirement is the equivalent to age-25 in bonds if you’re retiring at 65. I wouldn’t recommend that to many people. I consider myself to be a fairly aggressive investor at age-20 in bonds. I suppose a holding a higher stock allocation longer helps the long term performance numbers look better. However I know a number of people who were upset by the magnitude of the drop in the value of their Target funds in 2008.
I don’t think many of the people who invest in these funds truly understand how they work and that you can adjust the asset allocation to match your risk tolerance by selecting a target date that is loser or further away from your planned retirement date.
Sorry for the typos — writing on my phone.
I considered doing the lifecycle funds in the TSP. I decided against it because I have 30+ years until retirement, and I plan to keep my retirement account 100% equities for at least the next 5-10 years. When I get to the point that I’m ready to start getting more conservative, I’ll definitely reconsider them so I’m not tempted to “actively manage” my asset allocation.
L2050 is 89.6% stock with an automatic mix of large cap, small cap and international. That is pretty close to being 100% stock and lets them handle the mixing of stock. I was like you for a while, but decided that it was worth the trade off of not having to rebalance my stock mix so now I’m in L2050.
Really great post. I love the graphics. I also checked out the corgi blog. Very Cute. I think the stock percentages seem high because people are living longer and to compensate for inflation over a long retirement you have to stay in stocks. With the low interest rate environment we are in now the bonds really are just a shock absorber.
Not enough diversification in Vanguards Target Funds-only FOUR FUNDS!!
You gotta do it yourself with lower fees possibly but stay with Vanguard
So its not only the number of funds that determines diversification.
I’m assuming you’re not familiar with the 3-fund portfolio – a boglehead favorite?
http://www.bogleheads.org/forum/viewtopic.php?f=10&t=88005
I second that portfolio. I always tell my dad that’s the one he should start with. It covers everything with 3 funds and anything else is just overlapping the companies in those 3.
Each of those funds have literally hundreds of companies in them. You can easily be very diversified with 3-5 funds total. (US index, International Index, US Bond make up the infamous 3 fund account)
Addendum:
I think you confuse risk and diversification. There are really only 5 major categories. US, Internation, Bonds, Commodities, and REITS. Sure you can subdivide those and many do break US down into large medium and small but frankly you are quite well diversified with just the first three. The others do add more diversity but more volatility as well.
Keep in mind that those 4 funds hold a significant portion of the world’s stocks and bonds so it is extremely well diversified.
The difference in expense ratios may be $5K a year but it’s more accurate to describe it over 10-25 years – which compounded is in the hundreds of thousands of dollars. Not a good choice. Personal capital has a 401(k) analyzer that will calculate this for you, it’s free. I am a user but have no financial relationship with them.
Good resource. Thanks.
https://www.personalcapital.com/landing/401k/0014
TIAA CREF also has target date funds if your employer uses them. I noticed something funny how there were Lifecycle funds and Lifecycle INDEX funds I think fidelity does the same, wonder if other companies do that as well. The former being composed of more and more actively managed funds and the later being cheaper with holding index funds…
The Fidelity Freedom Index funds can now be purchased by anyone (previously restricted to certain retirement plans). The net expense ratio is 0.16% – comparable to Vanguard, and much less than what is listed above.
Just wondering where you got the .16%. (This not a “call out comment) I have my IRA at Fidelity and just checked out their website and it seems to say .72% for both Gross and Net. Of course I’m probably reading it wrong. Not sure if they’ll allow the URL https://fundresearch.fidelity.com/mutual-funds/fees-and-prices/315792663
Your link is to the “Fidelity Freedom 2025 Fund” when what you want is the “Fidelity Freedom Index 2025 Fund.” The link you want to use is: https://fundresearch.fidelity.com/mutual-funds/fees-and-prices/315793604
Doh! Thanks.
Exactly what I was going to suggest and what I have started using myself…huge savings, that is not well known or well advertised
I chose TLXIX tiaa-cref LIFECYCLE INDEX 2045 for my 403b. It seems pretty good, low expense. I assume these target funds aren’t good for taxable accounts? I am nearly out of debt and will be starting my taxable account in the next couple months.
Be careful some places have lifecycle funds with higher expense ratios then there lifecycle INDEX funds (TIAA cref and fidelity)…
sorry duplicate post, first one didnt go through initially.
Modern portfolio theory. You need more than three funds to cover the asset classes you should have in a well diversified portfolio
links for this theory?
http://en.wikipedia.org/wiki/Modern_portfolio_theory
The three fund portfolio represents a portfolio of nearly all the US and non-US equities in the world as well as all US based bonds including Government and Corporate bonds. It’s about as diversified as it gets.
The number of funds is irrelevant. What matters is the diversity of the holdings within those funds. The broad index funds such as Total US and Total International hold thousands of companies and are very diversified. Narrow specialty funds and ETFs such as those only investing in pharmaceutical companies are very concentrated and undiversified. Furthermore, you can have ten funds, but if they all invest in technology stocks, then their holdings will overlap and you will be no better diversified than just holding one of those funds.
Remember that funds are just a way to buy a basket of stocks or bonds. You want to choose your funds to get as diversified basket of stocks and bonds as possible.
This is a great article summarizing the complexities of target date investing.
However, this is just scratching the surface. How do you know that you are really well-diversified? The clue is to examine the underlying investments and asset allocations. Here are several observations:
1) The allocations might be way too risky. Because most dentists/physicians have as much as 80% of their assets inside retirement plans, you really have to be careful about your allocation inside the 401k plan.
2) Diversification. Even though 3-fund portfolios provide some degree of diversification, it is not nearly enough in my opinion. There is very little exposure to small capitalization stocks, and not enough to international stocks. The world stock market is over 50%, so this should be represented in your portfolio as well. An easy way to check how well diversified you are is to use Morningstar instant x-ray.
3) While target date funds can be a good choice (a one size that fits all) for individual employees who do not know much about investing, there are much better ways to invest inside your 401k plan. For more sophisticated investors I actually don’t ever include target date funds, using target-risk portfolios instead. This way they can put together a 13 asset class portfolio that is much better diversified, and with small cap and value tilts and more exposure to bonds. If all you have are several index funds, you can build a 3 or 4 fund portfolios.
4) One huge problem with target date funds is that the glide path exists in a vacuum. If the stock market falls, you don’t have to sell if you are in a risk-managed portfolio, but if your allocations constantly shift, you are at a risk of buying high and selling low. It also does not reflect your personal financial situation – just some average that might really not work for you.
5) Another problem is that a target date fund is NOT a retirement fund because it is not designed to generate income. Using a total bond market as an income generating investment in retirement is a poor choice. Also, presumably a target date fund might not work well in your specific financial situation – you might have a need for a more aggressive portfolio at retirement, or a much more conservative (income-oriented) one. And honestly, keeping tabs on the allocation is not worth it – I prefer to control the allocation at all stages. Who is to say that one’s allocation should change at all inside your 401k plan? What if you build up an after-tax portfolio of individual municipal bonds, thus gradually increasing your overall bond allocation without touching the 401k allocation at all?
6) A note regarding 401k plans for practice owners. If you have your own practice, using target date funds inside your 401k plans will still require that you educate your employees. You might be a sophisticated investor (after all, you read this blog), but your employees have no idea about investing. Using target-risk portfolios is a better way to make sure that they don’t mess up (which becomes apparent when the market tanks).
7) A note for those working for an employer with a 401k plan. If you don’t have at least 4 or 5 good index funds (and ideally you should have at least 20 or so to include major asset classes), then maybe you should lobby the company to include them. No reason to remain passive if your entire wealth is inside the 401k plan. Fees do matter – your plan should be using low cost institutional shares (or admiral if it is a small plan). While some might decide to use target date funds, you should have more choices than that in your 401k plan.
There are many different approaches that doctors and dentists can use, and I don’t believe that target date funds should be the default. Do the research or get some advice. Hoping that a single investment does it for you all the way is not a prudent way to manage your investments.
[Inflammatory comment deleted.]
“Just google it and learn”
Yes this is exactly the best way to research and develop your diversified portfolio. Again, the number of funds is not a sole determining factor of diversification. The 3 fund portfolio is very diversified.
http://www.bogleheads.org/forum/viewtopic.php?f=10&t=88005
[Sarcastic inflammatory comment deleted.]
Spouse (non-physician) 403(b) and myself (employed physician) 401(k) each administered by Fidelity, all index target date funds. Her ER is 0.15, mine is 0.01. To get the same stock/bond+cash percentage in each my target date fund is 10 years earlier than hers. That definitely took me by surprise. Mine has a significantly larger % in cash as well. I hadn’t thought about looking at the other funds to see if the percentages change how we would want them to. Guess I have a weekend project. Thanks for the great post.
Cash in a retirement plan is a bad move
3 funds is not a diversified portfolio
One could easily construct a single fund, let’s call it ALLFUND, that holds every single possible holding within the one fund. By definition, none of us could have any investment that was more diversified. It goes, if one can be diversified with one fund, then she could be diversified with 3 funds.
[Rude attack deleted.]
[Ad hominem attack deleted.] I second your post. Maybe Ken is thinking that Vanguard only holds 3 stocks, not the 15,000+ securities that make up the 3 fund portfolio?
It’s not the fund for everyone and I don’t use it, well I guess I do. I just have other funds, ie small cap, emerging markets, REIT etc. also to weight it in directions that I like.
The reason why in old times you had to choose multiple mutual funds, was because only 25% of the them were going to beat the market over 5 years. But you dont know which 25%. Hence you choose multiple of them. But with 3 fund portfolio you are not trying to beat the market, but mirror it.
A 3 fund portfolio can be very adequately diversified, actually.
Read How a Second Grader Beats Wall Street.
[Inflammatory comment deleted]
Those who promote three funds need to read a bit more, like swedroes book
ok, he is pretty respected member at Boglehead, here is his own article saying he is a passive investor, inspite of working for company.
http://seekingalpha.com/article/2009931-why-im-a-passive-investor-and-you-should-be-too
plus another recent one
http://seekingalpha.com/article/2271463-the-hurdles-are-getting-higher-for-active-management
I’m trying to figure out why you say the 3-fund portfolio is not diversified. Mr. Swedroe has written a lot of different books on different aspects of investing. Could you point me to which book you are referring?
Depending on if you’re referring to his Alternative Investments book or his Black Swan (a.k.a. Larry Portfolio) book, you could generate different arguments for why the basic 3-fund portfolio lacks diversification in certain dimensions.
There certainly are some arguments that you should be diversifying across different risk factors (i.e. small and value, not just beta) or alternative asset classes (i.e. real estate, precious metals, etc.).
It’s understandable for you not to agree with the 3 fund portfolio, Ken. I myself don’t go that route and think there are better options. But to say it’s not diversified is just inaccurate. I am extremely well read. Thanks
no fee based advisor wil put you in only three funds
target plans with vanguard have 4-5 but I believe in more
total stock total bond reit tips small cap intl bond emerging mkts
ginnie mae fund and you might throw in a few more depending on your AA model
You folks are all talking past each other and the fact is you’re both right, it’s just a matter of viewpoint.
If your view is that maximum diversification is owning as many securities as possible, then the 3 fund portfolio is “maximally diversified.”
If your view of diversification is that factors (such as small, value, momentum etc) should also be diversified, then Ken is right.
The truth is either style of portfolio will work just fine if you start early, save an adequate amount, and stick with it for decades.
Maybe WCI should do an article on this. I am curious as well. REITs are included in 3 fund portfolio, but TIPS and MLPs are not included. Small cap is only 7% weighted in three fund portfolio. I would like to know if I need to add TIPS, MLPs and REITS or increase the small funds to more than 7%.
I’ve done an article about this subject. Here it is:
https://www.whitecoatinvestor.com/150-portfolios-better-than-yours/
The point is any reasonable portfolio is fine if you stick with it and adequately fund it.
Is there a website, where one can enter a stock symbols to make up a portfolio, enter how much money invested and get the past performance? Most websites you have to find what the price of the stock was that day and enter how many shares you want to buy, instead of automatically finding the price on that day and asking how much money to invest rather than how many shares to buy.
I don’t know of one. Let me know if you do stumble on to one. It would be fun to play with.
Speaking of barebones 3 fund portfolios vs adding small/value tilts, etc., I just stumbled across this post from Rick Ferri: http://www.rickferri.com/blog/investments/avoid-being-an-out-of-style-investor/
Figures 1 & 2 are of most interest. Without calculating areas under the curves and guesstimating based on eyeballing these, I believe I’m seeing large cap winning out over small cap over the 30+ year period. It appears value fares better against growth.
What do you guys think about these figures, and if legitimate representations, what they imply?
Will this hold in the future? Nobody knows. To avoid having to guess, I prefer to call this equal weighting (as opposed to ‘over-weighting’). If I’m not sure whether large caps or small caps will do better in the future, I’ll split the allocation equally. After all, having more in large caps implicitly suggests that you believe they’ll do better. Of course, this might also be a statement that low caps are riskier, but the extra risk can handled in the fixed income portion of your portfolio. Look up ‘bounded rationality’ – this is how one can make sound decisions when we don’t know the future (or all the facts).
I’m not sure I see that. The data is quite robust showing a long term outperformance for small stocks and value stocks. You can cherry pick periods where that isn’t true. And your personal investment career may be over a period where that isn’t true. But do you really want to bet against it?
Top 5 Reasons Target Date Index Retirement Funds Minimize the #1 Danger (Yourself) in Investing
1) Your market timing is taken away in 3 automatic methods: indexing, rebalancing, and gliding. Now you are not tempted to guess the market with your allocation but you have a plan set in stone. All are tempted to gamble in stock/class picking or holding off on a rebalance or glide because one thinks they can predict the future market.
2) An added benefit to not timing the market is you get to save that time, which then could be used to add value to your life or invested in a few more >$100 hours in one’s professional careers.
3) You are more likely to find this fund in your 401k offering than a wide array of index fund options.
4) Investment taxes are not a problem even for the average physician investor (including the whitecoatinvestor himself) since $52k+/year can be stashed into tax advantaged retirement accounts.
5) The cost is the same as someone attempting to tilt (like the whitecoatinvestor’s ER 0.16%) or mildly elevated which will be more than worth it for the extra hours saved and no-foul-up automatic rebalancing and gliding.
Lastly tilting is not true diversification of your holdings – it is you seeking a higher return on investment than the market with its higher risk. If you prefer to spend your time tilting and rebalancing and gliding on your own for the next 50+ years, then God bless your discipline and the ultimate simplicity of complex investing, the Target Date Index Fund, is not for you.
While I agree with most of what you are saying, you did not address any of the points I’ve made above.
1) Allocation is way too risky given the market realities.
2) Not diversified enough – you can be much more diversified with individual index funds. Not enough exposure to small caps, emerging markets, foreign markets, value stocks.
3) Glide path not the optimal way to allocate assets and can subject you to additional risk.
4) You can’t retire with a target date fund – you will need an income-producing portfolio.
5) You still have to watch your allocation all the time because it changes, and so your overall allocation might become too conservative in the future.
Yes, doing it yourself is a great idea, and by all means, if target date fund is the only thing available, so be it. But if you plan to accumulate millions inside your 401k, you might want to make sure that you are doing the best you can rather than defaulting to a solution that might not work well for you. While it would be nice for a single investment to work for everyone all the time, the reality is that it does not. As a fiduciary, I can’t offer this type of solution to my clients (and I personally would never use target date funds myself, preferring asset-allocated funds instead when I don’t have any other choices).
Great comment, thanks for sharing.
Good points overall. Thanks for a good discussion. Most of your points just bring questions to mind for me:
1) What allocation do you recommend? Many argue that 100% stock is okay at the beginning stages of a 30+ year investment. If you look at the trinity study for post-retirement stock of 25%-100% had similar findings for a SWR of 4%. Plan inconsistency of risk allocation (willy-nilly changing stock percentage) would be more detrimental than altering based on how “conservative” you feel this year versus the next.
2) In a sense you are saying the market’s “exposure” to small caps and value stocks is not enough for you. You can change your exposure to Apple stock as well but no matter how big or how small you tilt, you are diversifying away from the market and therefore not truly diversifying your holdings.
As for foreign markets, your point is more valid. But also note that for more equal exposure to non-US markets the fees are greater so any benefit is marginalized. Plus the US market is heavily tied into foreign markets so a US titled account is already seeing most of the benefits/costs of foreign market diversification.
3) What path do you suggest? If not a glide, do you suggest a certain stable stock allocation for life? If not that, how about suddenly decreasing your stock allocation? If so, when do you pull the trigger (aka attempt to time the market)? I argue if you do not preset your path you are setting up a great risk of timing your stock allocation changes.
4) You can retire with a target date fund. You simply withdraw at the rate you are comfortable (or even better: your planned SWR). If you want to you could withdraw a large amount and buy an annuity or you can just watch your relatively conservative stock allocation possibly grow and leave an inheritance. A target date fund does not stop growing once that year is met.
5) Mute point: don’t you have to watch your allocation all the time if you are managing it? If you are changing your allocation plan on your path to retirement, are you not just timing the market and setting yourself up for risky changes? Even if you don’t use a target date fund, most would advise creating a plan and sticking to it. A target date fund is choosing a plan and not altering it based on your annual feelings. And yes, you should want your plan to get a least a little more conservative near retirement, at least for your basic necessities’ nest egg.
Yes, as a fiduciary you should not offer this to your clients. For one, if that was all you offered they could stop paying you and do it themselves. Instead they pay you – one who has all day to manage tilting, rebalancing, and gliding – and hope that you beat the market. I’d rather follow the market than have any real chance of losing to the market.
I would never promise to beat the market. That would be wrong. I’m with you – all I can do is try to get market returns with a bit less volatility. I’m also ok getting below market returns with a much less volatility as long as I can beat inflation (and let the savings grow vs. trying to get the highest return possible).
1) This really does depend on many factors. If you have accumulated a lot of money, you might want a smaller exposure to the stock market. If you have an inheritance/annuity/royalty, you might want a higher exposure. There are many ways to make this decision, and it is not a one size fits all. In general, even if you are diversified, having 100% of your money at risk at all times is not something I recommend. I prefer to have concentrated risk (say by overexposure to small caps, international markets and value stocks), but balanced with relatively safe assets such as US government bonds (not corporate bonds). Just a different philosophy of investing. This might not work for everyone.
2) You are right about the cost. It can be a little higher. However, using ETFs, the cost can be brought down significantly. Even with index funds you can still get plenty of good exposure at a relatively low cost. After tax you also have to worry about extra taxation (not all dividends are qualified).
3) Actually, this is a very good question. I also don’t think there is a one path for everyone. As before, this might depend on many changes in one’s finances. I prefer to allocate each account on its own, so some accounts might have a stable allocation. Those who own their own practice and who might expand or purchase other practices, their allocation might be different from whose who have static/steady job with a salary. For example, a practice owner can only put so much into their 401k plan. If they want to invest beyond that, it will have to be after-tax. Given the high tax brackets and investment taxes, there are tradeoffs in how to invest after-tax (whether to use a limited number of tax-advantaged stock funds/ETFs or municipal bonds, for example). Also, for someone with a high salary and a corporate 401k with a 18k deferral, they also have to worry about after-tax investing. They might also have a 529 plan, an HSA, Roth IRAs, etc., so they also have to coordinate their investment strategy across multiple accounts. This is one thing I have to worry about though – it is part of my job to make sure that the allocation is optimal (in the sense that it is the best allocation for a particular financial situation). So the bottom line is that the docs who do it themselves still have to worry about their allocation (even more so with a target date fund).
4) I disagree here. A target date fund is a very poor income generating investment. At that point you’d want to make sure that at least some of your investments have a protected principal (as much as possible). Having a total bond market for your retirement income is not a good idea. In retirement investments such as individual bonds and fixed annuities might make more sense. Also, most docs who retire might benefit from Roth conversions, so you might not keep all of your money inside your 401k. And again, we are back to the allocation question. You might or might not have a good allocation in ‘retirement’ (which might not really align well with the target date fund’s dates), so you have to basically keep track of what your current asset allocation is. My point again is that you have to make sure that this is the best option on the table rather than simply defaulting to it because it is there.
5) I agree about having a plan and sticking to it. Allocating each account separately makes my job much easier (and changing allocations becomes very easy as well – I am not expecting the doc to monitor their allocations, so this becomes my worry). My point is that there is a lot more to a long term plan than a 401k plan. I think that most docs can either do more research or hire competent help to help them get more out of their money. I just don’t think that a target date fund should be the central theme of anyone’s planning UNLESS they’ve done the research and determined that all the other options are worse!
A few comments on your discussion. I’ll use the same numbers.
1) You can choose a TR fund by asset allocation instead of date if you don’t like the AA. Sure, it might not be what someone who is really into this stuff wants (see my portfolio) but coupled with an adequate savings rate and good discipline TR funds are certainly an adequate plan.
2) It’s easy to keep costs low either way.
3) If you change your asset allocation based on what’s going on in your life rather than what’s going on in the market, that’s hardly market timing. Might it work out better or worse than a preset glide path? Sure. Life’s risky, get used to it. My asset allocation hasn’t changed in the last decade. Little 1% a year changes don’t matter much anyway IMHO.
4) I’m with EMResident on this one. It’s not called Target Retirement INCOME fund for nothing.
5) Checking to make sure the TR asset allocation is what you want every few years doesn’t seem like much work to me.
Avoid annuities