Target-date-funds. What are they? Investopedia tells us they are “mutual funds or exchange-traded funds (ETFs) structured to grow assets in a way that is optimized for a specific time frame”. Today, we’ll be looking at Vanguard’s target-date-funds.
Target-date funds are a healthy investment option for a variety of reasons. First of all, TDFs appropriately reflect risk depending on which year you plan to retire. If you plan to retire in 2060, and you’re 25 years old now, most of your investment allocation will be in stocks (95%) compared to bonds (5%). This is ideal because your portfolio can more readily take market drops early on in your life while also riding on any high-performance periods the market has to offer. Its performance is often reflective of a few index funds such as total U.S. stock market performance, international stocks, bond markets, and international bonds. This ensures you’re exposed to a wide swath of key performers during good times and bad.
Another phenomenal benefit of TDFs are their expense ratios. For example, the Vanguard Target Retirement 2055 Fund (VFFVX) has an expense ratio of 0.15%. This is CRITICAL. Many retirement accounts such as employer-sponsored 401(k) plans can have expense ratios of 1-2%. For example, if you have $10,000 saved in a fund with a 1% expense ratio, you would technically pay $100 per year just to have the funds managed. This is why it is important to pay most retirement fees upfront instead of letting your advisor take 1% to 2% of your retirement every year. Ramsey Solutions illustrates the importance of fees here: “If you paid a 0.5% fee on your account balance each year, your retirement savings would grow to $500,000. Bump those fees up to 1% and you would end up with $436,000. That’s still pretty good! But what would happen if you paid 1.5% in fees each year? In that case, you would finish with $380,000 after 30 years”. Wow. Think about that. The difference of a measly 1% slashed that individual’s retirement by $120,000! That’s why investing in a target-date fund like Vanguard’s is critical. 0.15% compared to 1% or 2% can save you hundreds of thousands of retirement savings in the long run.
Ideally, aim to use a retirement vehicle such as a Roth IRA to invest in your first TDF. This allows you to invest cash you’ve already paid taxes on to grow tax-free in the TDF. Earnings will not be taxed and you’ll be able to withdraw from this fund once you turn 59 ½ years old. Another helpful benefit to utilizing a Roth IRA is that any cash you put into the account can be withdrawn at any time without penalty. Say you’ve invested $10,000 into the account and it’s made $3,500 in returns, you can withdraw that $10,000 at any time. This would only be appropriate in the case of a severe emergency, but it is a useful thing to keep in mind when choosing retirement options.
Target date funds are a great option to consider when it comes to choosing a good investment. Passively investing $25, $50, or even $200 in a TDF can really cause your retirement savings to grow over time and provide a healthy secondary retirement foundation in addition to your pension or 401(k) plan.
