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Money Meets Medicine Podcast

MMM 75: Should You Use Target Date Funds?

There are so many different investment strategies when it comes to how to reach financial independence. One of those strategies we talk about often are the different types of Target Date Funds. But, you might be thinking how do you know if you should use Target Date Funds?

Larry Keller

Today we will get into the details of the good, the bad, and the ugly when it comes to using Target Date Funds so you can determine whether this is a strategy that fits your needs or not. Let’s jump in a figure out how to best utilize Target Date Funds in your investment plan.

Today You’ll Learn

  • The good, the bad, and the ugly of Target Date Funds
  • Determining whether a Target Date Fund fits your needs or not
  • When and how to utilize TDF’s in your investment plan
  • And more! 

Resources 

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In many retirement plans, target date funds are often the default provided to you by your employer, but are these the best funds for you and your needs? Keep listening to find out.

Welcome to the

Money meets medicine podcast, where we talk all about the personal finance topics you wish you had learned in

Medical school. I'm your host, Jimmy Turner. And here's your cohost who is, believe it or not a true believer because his favorite music artists is none other than Justin Bieber, Ryan Inman, a true believer. Is that what they call themselves? Yep. Okay. I think, I don't know. Who's the actual fan over here. I

Don't even think Justin Bieber likes Justin Bieber, but Hey, we'll roll with this. He's coming up. I'll be a believer today. That's actually a fun word to say the Lieber girls at the time. Yeah. Oh God. Justin Bieber Mohamad. All right, today, we're going to be talking all about target date funds. We've looked back and seen that the shows that we do as specific, deep dive into a topic, they ended up being more popular. And one of the most popular things that we get involved with, or at least asked around investing is around target date funds, because this is talking about investing and because I'm an sec registered investment advisor and a financial planner, I have to give the other disclaimer that this is not investments or financial planning or insurance or any other type of advice that you could think this would be, I don't know you or your situation.

So this is educational in nature, and we will probably have some really bad jokes mixed in between there, but that is it just education. So please do not make any changes to your financial portfolio or to your investment portfolio or finances or anything. Honestly, I don't think you should do that. Listening to anyone or watching anything or reading anything, unless that person knows you in your specific situation. But specifically for this, we're going to jump into the pros and cons of targeting funds. But I got to give that disclaimer, before we jump off also, before we jump into the deep end of the pool on target date funds, let's talk about today's sponsor. And if you've ever considered practicing medicine in a different way, or whether you're burnt out or you need a change of pace, or you're looking to supplement your income, locum tenens might be a solution for you.

And if you're not sure where to start, check out locum story.com and that's a place where you can get real unbiased answers to your questions, the answer, basic questions like what is locum tenens to more complex questions around pay ranges and taxes and various specialties and how locums tenons can actually work for you. So go to locum story.com or check them out Dr. Podcast network.com/locum story and get all those answers to those questions that you may have. And just like we always do. We're going to leave a link to that awesome website in the description of the show that you're listening to us in right now. All right, Jimmy, I'm going to let you start the show and tell us where you'd like to take this target date fund fiasco,

Because we all, you're going to take over at some point,

But naturally, all right, Jimmy. Good talk. No, I'm just kidding. Oh man, I'll give you two seconds of fame.

That's right. So I had someone to ask me about this the other day, and it was an interesting thing because I get certain questions all the time. Target date funds, backdoor Roth, individual 401k versus SEP IRA is like people really like talking about some of the nitty gritty. And so I thought this would be really cool to talk about the good, the bad and the ugly of target date funds. And so I'm going to organize the show just like that, actually, because I think that there is some good, some bad and some pretty ugly about target date funds that should make you just consider whether this is something right for you. And so this is gonna be like Ryan said educational nature, but I think it's also really helpful because many people don't realize that your default in a 401k or four, three B at work may be putting you into a target date fund of some kind.

They may say, Hey, what's your expected retirement year. And then based on that, they put you in the retirement fund at that fits that answer. And that's the default that they plug you into in their portfolio. So it kind of begs the question if that's the default, is that a good or a bad thing? And one of the good things that I'll start off and I have to give credit where credit's due, right? He can't give a fair shake at something if you're not gonna be honest about the good and the bad, but one of the best things, in my opinion about target date funds is it makes it super easy to get the behavioral part of finance incense. We hear this all the time on the show. Money is 80% behavior, 20% numbers. I really do believe that. So this gets the 80%, right?

Like in spades. It really does. It makes it very easy to ignore that fund. Cause every year inside that one specific fund, it automatically rebounces in that fund. But like your target date fund inside your 4 0 3 B or your 401k is just going to automatically invest based on whatever the target date funds asset allocation is based on your age and the target date that you were going to retire. And so in a lot of ways, like the best thing about a target date fund is that you can just set it and forget it inside of that one account. So if that was the only account that you had, it would do it pretty well. Like it would do a lot of the things that we talk about in investing pretty well. And sometimes it even includes low cost diversified index fund options as the default option inside those funds.

You know, so those are some of the big picture highlights, all the target date fund that I think make it really appealing to a lot of people that don't want to rebalance their own portfolio every year. They don't want to be in the nitty gritty, pick their own funds at their employer. Maybe their employer doesn't have a total stock market index fund. And so they just want to pick this one because it's just going to take care of everything because otherwise they'd have to pick five or six different funds to really get diversification across the funds and have to reset those every year in terms of their asset allocation and with targeted fund, you'll have to do that. So I got to give credit there because this is the one thing that I think target date funds do incredibly well.

Not everyone has the ability to use a target date fund or a life cycle fund. If you're employed by the government, you have the TSP and those are lifecycle funds and you might be going well, what the heck is a targeted fund? Anyway, it's actually really easy to see on the titling of the investment itself. It'll say a specific year, and that is the year that you're expected to retire. So if you were in a 2040 fund and it'll have some other verbiage in there, but it'll give you a year 20, 40, 20, 45, 20 50. And that is the year that you're expected to retire. And inside there, the way that they construct those is the sooner you're going to retire. So the closer it is to 2021 on that target date fund, the more conservative it is. So the more bonds it will own, the less stock you will own.

What they're trying to do is say, you've become more conservative as you've aged. You need to take less risk as you've aged, not no risk, right? They didn't eliminate stocks because spoiler, even when you're retired, you're going to want to own stocks, right? You need something to provide that extra alpha return in your portfolio. So it keeps up with inflation and all sorts of stuff. But when you actually sign up, sometimes it defaults you in, sometimes the forms, Lasky, what you'd like to go, and you check the box that you totally forget that you checked. Sometimes it doesn't actually put your money into anything and you have to literally log in, see the investment options and make the decision yourself. We've had several people that have been doing the right thing and putting money in and have never invested it. It's like when you put money in your Roth IRA and you're like, okay, it's done because your 401k or your 4 0 3 B at work had already put you into that investment fund.

So you thought you were invested when you do the IRA. You're controlling those. There's no set it and forget it concept like you are actually going in and placing that trade and you have to initially place the trade. So just be careful. You want to give that high level disclaimer, as we go through this, that, yeah, just because you put money in does not mean it's actually invested. It also means that if you are, let's say an early career physician and you expect to retire in 2055, that doesn't mean that you have to put your money in the 2055 fund. A lot of people think, oh, that's what I'm going to retire there for. That's what it is. We've talked about the need and the ability to take risk. You may have a need to take risk, but you might not have the ability to do that.

And what I mean by that is let's say that you're not saving a lot of money, but you want to retire or you have more aggressive plans. You're going to have to take more outsized risk. Therefore you might have to own more stock than bonds in a very considerable way in order to potentially achieve those investment goals that you have because your savings rate isn't high enough. But if you're a very conservative person and you have that competing goal, then you might not have the ability to take the risk. You might panic and worry if your money's moving in a volatile market up and down 10 or 20% in a year. So we have to factor all those in play, target a funds. They don't care. They don't care. What you're needing your ability to take risk is it is set it and forget it in the sense of this is the portfolio that you're in and that's it.

There's no change in it. So you're in a 2055 fund. You're probably 95% in stock and 5% in bonds. They don't know you. They don't know how you're investing. They don't know your personality. They don't know how much debt you have. They don't know how much you're saving. They don't care. The fund is designed to give you exposure at that year of retirement. And the further the years that go out, the more stock you will own. So if you're a more conservative investor and you don't need to take a lot of risk in order to retire, you might be in a 20, 35 fund or a 20, 30, or 2040 fund. If that's the case where you owned 40% bonds and 60% stock, even if you're 33 and just start in your brain, new attending, that might be okay, cause you make 600 K a year and you only spend a hundred K a year. You don't have to take a bunch of risk, even if you want

To. Yeah. And I think that's super important to mention because that gets into the bad, right? Like you may be more or less risk-tolerant based on your personality, your situation, your experience, and the target date fund, the, your end. And you can choose different targeted funds then when you wanna retire. And nowadays it's such an interesting thing, right? So if you go back and I don't know these exact numbers, so I'm gonna screw them up. I think it's 50 or 75 years. I don't even think you have to go back a hundred. Like it's a relatively new idea. Like back a hundred years ago, people just work until they die. Like that's what you would expect you to do. You expected to work until you die.

You also worked for the same company forever. And he didn't switch jobs every two years because something went

Wrong. So everything's changed. And now it's like, okay, well retirement was 65. And then now our generation is coming along and we're like, why can't I live the life that I want to live sooner than that? So what if I retired at 55 or 50 or 45? And so all of these target date funds are set on the idea that you're going to retire by that specific date, but they don't take into account how old you are. So if you're on a path to financial independence retire early, for example, if you're one of our fire friends, your path is going to look probably a little bit different than the traditional person who saves for 35 years and then retires at the age of 65. And so I bet your asset allocation may be a lot more risk tolerant early and for a lot longer than someone who isn't in that situation, because you could technically wait to retire if things weren't looking great.

So just to point out that like everybody's situation, everybody's philosophy and asset allocations are different based on all of these different variables and varieties. And I'll give you another one. And this is one of my personal pet peeves, because I'm not a huge fan of investing a ton in international stocks. And that's just my flavor. Like when I think about this and I think about what people say in this space, I do want to have some exposure to the international market, but I don't know that I want 35% of my portfolio to be international in these funds. Oftentimes you'll find that 30 to 40% of the fund is international and a target date fund. That's not always true, but in several that I've seen when you click it and you open up the portfolio and it tells you what the asset classes are, it's pretty surprising how international they are.

And if you like international, that's fantastic. If international is not necessarily something that you want to be putting 40% of your portfolio in, then maybe not. And I know like the one that we have at wake, when I looked at that, I want say it was like 30 or 35% international. I just thought that was an interesting thing that most people who don't look inside their target date funds, they just click the box may or may not be aware of. So while these do help, you forget things, they also may help you ignore some things that you maybe have an opinion on like the international exposure. And one other thing that goes along with that is if we're talking about being able to rebalance for you and the kind of stocks and bond funds that they have inside of these target date funds, because these target date funds are usually a mixture of other funds within them.

Someone's managing those for you. And they're not always passively managed index funds. There's a good chance. They might be actively managed index funds and the average expense ratio for a target date fund. When I looked it up recently, it was like around 0.5% and they can be much higher, but like at wake and this is where I'm getting a lot of my information, right? So like our index funds are super low. We've got actually really good retirement options where I work is 0.05% for just, you know, a regular index fund. But for any of the target date funds it's 0.4. So it's eight times more expensive to be in a target date fund than to rebalance yourself. And so all of these things, the increased fees, the increased international exposure, they may be things you care about. They may be things that you don't care about at all, but you should at least be aware of them because they are potential drawbacks depending on what your thoughts are. And again, going back to that risk tolerance thing that Ryan's talking about, like that could be also another drawback. So this has to go in my opinion, in the bad category, because you can't determine these things yourself, it's just, they are what they are. And you can either like them and cook the fonder. You don't like them, right?

I will say that some of your employers will offer you accounts that will actually have insurance policies wrapped into them. Any target date fund is probably going to be a lot better than any insurance product that's inside that. And if you have an insurance product inside yours, you have to take a long, hard look. Is it even worth putting money into this? If that's your only option, we talk about maxing out all this stuff, but if you max it out and it's going to a permanent insurance policy, that you are not going to want to take with you, then you're going to be, even if it's paid by your employer, you're going to have tax on that. If you move it out and you're contributing, like it gets ugly. So target date funds are not horrible in the sense of that. They could be more expensive.

We looking at Taylor's, I can't use her current job because she has a TSP, which is the absolute best account, I think humanly possible out there. But when she was a fellow at UCFD, they had a fantastic retirement plan and their expense ratios were like, 0.004 or something like microscopic. Yeah, those are good ones. You should probably invest in those. Even if you could recreate it, just look at the target date fund and try to use that. And it's going to be extremely cheap. It was a great option. And if you could turn around and look inside the targeted fund, and let's just say that it's made up of four individual funds, total stock, total international stock, total bond, whatever. And that is available to you. We'll just add up the expense ratios. And if it actually ends up being lower, just to do the individual ones, you should probably do that.

Even if it's 0.01 lower, I probably would still do that. And then check in with your own risk tolerance. Once a year, everyone should be touching their financial plans multiple times a year, and your investments multiple times a year as you rebalanced. But 401k is in four, three B's are nice because they allow you to put money in and dollar cost average in with every paycheck. And most of them have it to where you can automatically rebalance. So if you've talked to an advisor and they're going, oh, but I'll manage this and I'll go in all the time and make trades 90% of the time, it can be automatically done. And you don't need to pay someone to do that flip obscene that actually exists. But it does unfortunately in this space, but with the targeted funds, make sure that you understand what is inside them, how much risk you're taking, how much you're paying for the opportunity to place your money into there.

See if he can do it individually and it's cheaper. Or these are all little pieces that you're putting together. And I will just say this in some of you will be doing this. And I don't mean to be offensive buying to target date funds that are deferring years doesn't make any sense. Just look at, let's say it was a 20, 25 fund and a 2055 fund and just creating random numbers here. And one is 90 10 and the others 60 40, all you've done is about two funds that are essentially going to, if you put equal amounts into them, give you 70, 30 or 75, 25 or whatever that math is. It's not like it's another special sauce or something else that you're diversifying differently. It's usually the same stuff in both of them just owned in a different percentage. If it isn't, you have a weird system, because that goes against the grain of what almost every other target date fund or lifecycle fund is.

So you don't need own too. You just need to own one of those, but do your due diligence and dig in and find out what exactly this owns and how it works. Cause it's a lot of money. If you're putting $19,500 away every single year, and that money grows at six or 7% a year, you wake up 10 years from now and you're going to have hundreds of thousands of dollars in this. You need to understand what you're putting your money into. And sometimes the target date fund is the right spot. And sometimes it isn't.

Yeah. The other thing that kind of dovetails into that, and this gets into the ugly side of PDFs, target date funds or lifecycle funds is that many physicians that get into the personal finance space and they start maxing out their accounts and their Macs, not their 401k or their forty-three three B they're maxing out their 4 57, the HSA, the backdoor Roth IRA. And they get to the point where they have a taxable brokerage account for extra money. Cause they're trying to get to their annual savings number to be able to retire by the age that they want at that point, like you've got six different accounts and not all those accounts are going to have all of the same opportunities and investments inside of them. And so what ends up happening is like, you're great. You have this one target date fund in your 401k, but then you have to consider all of those other funds in all of the other vehicles that you have and your asset allocation overall.

And so great. Your target date fund in that one out of six is rebalancing itself each year. But unless that one fund matches the portfolio that you're putting into each and every single one of those vehicles, then it really doesn't help you as much as it would if it was just the only thing that you had an investment in. And the reason I point that out is because particularly when you get into a brokerage account and you start considering tax efficiency and you're like, oh, I want to put my I really tax inefficient stuff. If I can, in my tax advantage vehicles. And I want to put my tax efficient stuff in my brokerage account, you might not have all the same funds in each of those five or six things. And so as you go to rebalance, that really awesome, great thing about a target date fund about rebalancing for you can be negated a bit because of the variety of accounts that you have and having to do it anyway,

Odds are is that the target date fund is your training wheels. Before you figure out how to thoroughly invest in a walkthrough and build out portfolios. And if you are single or married and you both decide, no one wants to be the household CFO, you just need to get money in and invest, but you don't want to deal with any of this stuff. Target date funds have a fine option for a little bit, but at some point you're going to look down and it's going to have six figures in it. And if you're the type of person that doesn't care, you need professional help reach out to us financial planners or physician wealth services or happy to help you out. But at that point in time, you need to say, okay, training wheels need to come off and you need to understand what are all your options?

How do you build out a portfolio according to your need and your ability to take risk, and you're going to lay everything out and then you need to rebalance it probably quarterly. Or if we have a really bad month, like March of 2020, that could be the exception that you like, Hey, look, the market dropped 35%. Let me go buy more stock and sell off some of these bonds. And you're buying low, right? The whole concept of rebalancing is it's forcing you to buy low and to sell high, right? The things that you want to do, most people buy high and sell low. Those are things you don't want to do. It's pretty much losing money. You don't want to do those things. So the nice part about having retirement accounts and other it's targeted funds or not is that your dollar cost averaging in, but you will need to, at some point, expand your investment horizon out of target date funds and into something a little bit better.

They have a little more control over. So when you are trying to rebalance, according to your risk tolerance, it's going to be a little bit easier and it isn't going to constantly move and change and blow things up. So hopefully this was helpful for you guys to understand a little bit more about targeted funds. Please don't buy multiple of them. That makes no sense. You also should not be buying any target date funds and like your IRA that you can control and buy any investment possible. Targeted funds are only if you have really bad investment options and there's nowhere else to turn, or if you want to be lazy for the next year or two, because you're just starting out and it's not a ton of money yet not to be offensive. That 19,500 is a lot of money, but over your career, it's not that much.

You just say, Hey, look, I want to practice just getting into my practice and the best attending I can be and are I'm a resident and I'm barely sleeping. I just need to get something in. It's not, that's a couple hundred bucks a month. Fine targeted funds, perfectly fine. But again, think of it as like training wheels. At some point that comes off and you need to actually develop a real investment plan and targeted funds. Most of the time, we're never going to fit into it. Hopefully this has been helpful for you guys. We really appreciate all of you listening before we go. We want to just say again, a special thank you for our sponsor today, which is locum story. And they're an excellent resource for all of you to understand more about locums and pay structures and how different specialties work within the locums area.

So you can check them out by going to locum story.com or Dr. Podcast network.com/locum story. And the link like we always do is in the description of the show that you're listening to us in right now. So again, just always, when we go through a show that is heavily about investments, I want to say that this was not financial planning or investment advice. This is just two dudes nerding out on some money topics, and hopefully educate you a little bit and giving you some more food for thought, but it is not specific financial advice. So with that, you can hear the disclaimer one more time, but just in a lot cuter voice, I have a great week everyone, and we'll see you next Wednesday. Cheers. Take care.

Hi dad, Dr. Jimmy Turner is a practicing anesthesiologist. Mr. Eyman is a fee only financial planner. You should know that this show is not personalized financial advice free. In fact, the show is only for your general education and entertainment purposes. So keep listening to learn how to become an athlete yourself, angel girl, or go find a great fee only financial planner like Mr. And Mitch create a personalized financial plan for you.

TPP

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