Target Funds for a casual investor - benefits/drawbacks

Question

I want to invest in something but don't have much knowledge; I'm considering a target fund based on approximate retirement date.

What are the benefits / drawbacks to a casual investor, of investing in such a fund?

Answer 1

Target date funds exist for the explicit purpose of being the sole investment of people who do not know much about investing and do not want to. Therefore they are at least a pretty reasonable choice for this purpose. "Best" is a very strong word.

Given the fact that you came here asking about it, I wonder if you really fit into the camp of people who do not wish to understand investing. The next step up in terms of knowledge and improvement in investing quality would probably be a three fund portfolio or perhaps one of the so-called lazy portfolios. Some of these portfolios may require you to make a little decision about how much money is in certain asset classes, but not much.

The problem with target date funds is that there is not a well-established benchmark for what should be in these funds. There's a general feeling that older people should have more fixed income and less equity in their portfolio, but even this idea is questionable on a theoretical level. Given that, there's even more uncertainty about the magnitude of desirable portfolio changes as you age--your retirement date is probably not a good proxy for your risk tolerance. Recent research has shown that target date funds from different providers have pretty different portfolios from each other and that they make investments that are beneficial for the fund family at the expense of the investors. Their fees are slightly higher than you would get by doing it yourself. Really savvy investors don't think particularly well of them--of course, savvy investors are not the target consumers.

Whether a target date fund is best for you depends on your alternative. If your alternative is to hire a financial planner, then choosing the target date fund from a really reputable provider instead will save you a great deal of money and will provide a more sound set of investments. On the other hand, if your alternative is reading the wiki I suggested and buying a few reputable funds, then I think you will be able to do a little better on your own than you will with a target date fund.

Answer 2

You could also invest in a balanced fund. They are similar in nature to Target Date funds in the sense that they are meant to be one-stop shopping for mutual fund investing, with the exception that they aren't necessarily geared towards retirement and you have move liberty to choose where your assets are allocated (depending on the fund). For example, a balanced fund may be 60% Stocks (Domestic and Foreign) and 40% bonds (Domestic and Foreign), but another might be 80% Stocks and 20% Bonds.

Also something a lot of Target Date funds do that balanced funds don't, many Target Date funds rebalance automatically as they get closer to the Target Date, shifting asset allocation from riskier investments (such as stocks) to less risky, but less profitable investments (like bonds).

For example. Today a Target Date 2060 Fund might be 80% Stocks and 20% Bonds, but as it gets closer to 2060 the fund balance might shift closer to 20% Stocks and 80% Bonds

Answer 3

Target Date Funds can be a great option. One of the things you should consider is that it has a (relatively) low expense ratio.

Further reading (Barrons):

A target date fund (TDF) is a compilation of many other funds that invest in stocks, bonds, and maybe a smattering of more esoteric things like real estate and commodities. As the investors, the only real decision you have to make is when you plan to retire, a.k.a. your “target date.”

Once you make your pick, say 2050 or 2060, the folks running the TDF take on all the heavy lifting, building a diversified portfolio of global stocks and bonds based on reams of data.

[...]

Is the TDF in my workplace retirement plan cheap enough? According to Morningstar, the average asset-weighted expense ratio for TDFs -- the annual fee the funds charge -- was 0.71% last year. That’s a lot better than the near 1.00% average charged five years ago. But it’s still not all that cheap. Some TDFs that invest in index funds charge less than 0.20%, while other TDFs that invest in actively managed funds charge 0.80% or more.