Are term funds good for your retirement?  Yes and no.

Are term funds good for your retirement? Yes and no.

(Adam Levy)

Target date funds are a common choice for employees in their 401(k) and other retirement accounts. The set-it-and-forget-it approach makes investment decisions simple and removes the need for any portfolio management. Everything is done for you.

Although they are a very common choice among retirement savers, they are not always the best choice. Plus, retirees need to take a hands-on approach to their wallets if they want to get the most out of their nest egg.

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What to look for in a good target date fund

A good target date fund will consist of simple exchange-traded funds (ETFs) or index mutual funds with low expense ratios. There will be no actively managed high fee mutual funds in the Portfolio. On top of that, the target date fund won’t charge much, if anything, in terms of management fees. After all, a computer algorithm could manage the fund. (That’s the whole basis of the robo-advisor industry.)

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Basically, it’s about keeping fees low.

Spending ratios on target date funds have declined in recent years. The average expense ratio for a maturity fund was just 0.34% at the end of 2021.

Unfortunately, many 401(k) plans do not offer a family of low-fee target date funds. If so, it may be worth doing a little extra work and investing in any low-fee individual funds that may be available, rebalancing manually if necessary.

Do you fully agree with target date funds?

It is important to note that an investor must be all-in on target date funds for them to truly work as advertised. If you invest in additional stocks or sector ETFs alongside, you change the balance of your portfolio.

At this point, you might as well invest entirely in individual ETFs that give you more flexibility and control rather than sticking to the restrictions and potentially higher fees of target date funds.

So if you have decided to be a target date fund investor, you should be a target date fund investor for all of your accounts. This is when they work best. It makes your investment choices extremely simple and means you never have to worry about your account, rebalancing assets or thinking about selling until you’ve reached retirement.

Target date funds will hold your retirement withdrawals

If you can find a target date fund with a low expense ratio and invest money in it consistently month after month, it will do a pretty good job of getting you into retirement. Once you reach retirement, however, most target date funds don’t do as well at retaining your assets.

A recent study found that target date funds aren’t a great option for those who are already retired. “Target date funds do not support higher withdrawal rates, significantly limit upside wealth accumulation, and fail to improve downside protection,” wrote researchers at the University of Arizona and the University of Missouri. In other words, you won’t be able to safely withdraw as much from your portfolio in retirement, and you’ll leave less to your heirs.

The conclusion is logical. Target date funds become extremely conservative in retirement. The example fund used by the researchers increases its bond and treasury bill allocation from about 65% at retirement to a terminal allocation of 83% 15 years after the start of retirement. With the vast majority of the portfolio allocated to bonds, the investor will not see much in terms of capital appreciation.

A better retirement portfolio is the classic 60/40 portfolio, which allocates 60% to stocks and 40% to bonds. The investor must regularly rebalance, but they can withdraw more from their portfolio while generating more wealth over time.

Aim carefully

Target date funds can be a useful tool for reaching retirement without having to make investment decisions. If they help you invest and stay invested throughout your career, they can be a great tool. But investors, especially retirees, should explore all their options to make sure a target date fund is right for them.

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