Many physicians don’t want to think too hard about investing. There are a lot more fun things to do in life than worry about the minutiae of index funds.
One of the best investments for beginner investors are target-date funds. It’s a great way to get started with investing, while you learn more about the principles of asset allocation.
But there are literally hundreds of target-date funds available. How do you pick the target-date fund that’s right for you?
Benefits of target-date funds
Target-date funds are portfolios of index funds whose asset allocation changes with time as you get older. In general, the portfolios become more conservative (i.e., more bonds, fewer stocks) as you get older and your investing time horizon shortens. There are many advantages to target-date funds:
It doesn’t get much more simple than one fund. You buy a single mutual fund, and all of your investing is done.
With a single target-date fund, you get exposure to a wide variety of index funds. Most index funds will be diversified, but only within an asset class, such as international stocks, or U.S. bonds. With a target-date fund, you are able to be invested in multiple asset classes within a single fund.
Adjusts asset allocation over time
Most investors will choose to be more conservative with their investments with time. When you are young and have a long investment time horizon, you can afford to be more aggressive with your investments and include more stocks with your portfolio. However, as you get older and you get closer to your retirement, you’ll want to be more conservative and include more bonds in your portfolio.
Target-date funds take care of adjusting your asset allocation over time, and your portfolio will gradually become more conservative as you get older.
Rebalances for you
Rebalancing is an important part of any investment asset allocation strategy. It can be time-consuming and stressful for new investors. Target-date funds take care of rebalancing for you, so you don’t have to worry about it.
The best target-date funds have very low expense ratios. They may not be as low as the individual index funds, but they still have significantly lower expense ratios than the typical actively-managed mutual fund.
For some, the decreased flexibility of a target-date fund would be considered a disadvantage. But for many investors, the inflexibility of a target-date fund keeps them from making bad investment decisions. It’s easy to shift from the S&P 500 to international stocks to cryptocurrencies based on the flavor of the month in the financial markets. Target-date funds help investors keep a steady hand, forcing them into a balanced asset allocation that may not be absolutely optimal for every investor, but will work for the majority of investors.
How to select a target-date fund
Step 1: Decide whether a target-date fund is right for you
A target-date fund is not for everyone. If you want to absolutely minimize your fees, then using a portfolio of individual index funds will be slightly cheaper than a target-date fund.
The other major reason not to purchase a target-date fund is if your risk tolerance does not match that of the target-date fund. The target-date fund’s asset allocation is designed to match that of the typical investor, but if you have a lower risk tolerance than the average investor, than the target-date fund will be too aggressive for you. Choosing a fund designed for someone 10-20 years older than you is not a good alternative, because the asset allocation is designed for someone retiring 10-20 years earlier.
Step 2: Pick a mutual fund provider
In general, you should pick the target-date fund from the company where you invest your money in order to minimize transaction costs.
Vanguard, Fidelity, and Schwab are the three major players in the target-date fund market. You can’t go wrong with any of these three options.
Vanguard calls their target-date funds “Target Retirement Funds.”
|VTINX||Vanguard Target Retirement Income Fund||0.13%|
|VTXVX||Vanguard Target Retirement 2015 Fund||0.14%|
|VTWNX||Vanguard Target Retirement 2020 Fund||0.14%|
|VTTVX||Vanguard Target Retirement 2025 Fund||0.15%|
|VTHRX||Vanguard Target Retirement 2030 Fund||0.15%|
|VTTHX||Vanguard Target Retirement 2035 Fund||0.16%|
|VFORX||Vanguard Target Retirement 2040 Fund||0.16%|
|VTIVX||Vanguard Target Retirement 2045 Fund||0.16%|
|VFIFX||Vanguard Target Retirement 2050 Fund||0.16%|
|VFFVX||Vanguard Target Retirement 2055 Fund||0.16%|
|VTTSX||Vanguard Target Retirement 2060 Fund||0.16%|
Fidelity calls their target-date funds “Fidelity Freedom Index Funds” (don’t buy the Fidelity Freedom Funds, which are actively-managed and have a higher expense ratio).
|FKIFX||Fidelity Freedom Index 2015 Fund||0.10%|
|FLIFX||Fidelity Freedom Index 2015 Fund||0.10%|
|FPIFX||Fidelity Freedom Index 2020 Fund||0.10%|
|FQIFX||Fidelity Freedom Index 2025 Fund||0.10%|
|FXIFX||Fidelity Freedom Index 2030 Fund||0.10%|
|FIHFX||Fidelity Freedom Index 2035 Fund||0.10%|
|FBIFX||Fidelity Freedom Index 2040 Fund||0.10%|
|FIOFX||Fidelity Freedom Index 2045 Fund||0.10%|
|FIPFX||Fidelity Freedom Index 2050 Fund||0.10%|
|FDEWX||Fidelity Freedom Index 2055 Fund||0.10%|
|FDKLX||Fidelity Freedom Index 2060 Fund||0.10%|
Schwab calls their target-date funds “Target Index Funds” (don’t buy the Schwab Target Funds, which are actively managed and have a higher expense ratio).
|SWYAX||Schwab Target 2010 Index Fund||0.08%|
|SWYBX||Schwab Target 2015 Index Fund||0.08%|
|SWYLX||Schwab Target 2020 Index Fund||0.08%|
|SWYDX||Schwab Target 2025 Index Fund||0.08%|
|SWYEX||Schwab Target 2030 Index Fund||0.08%|
|SWYFX||Schwab Target 2035 Index Fund||0.08%|
|SWYGX||Schwab Target 2040 Index Fund||0.08%|
|SWYHX||Schwab Target 2045 Index Fund||0.08%|
|SWYMX||Schwab Target 2050 Index Fund||0.08%|
|SWYJX||Schwab Target 2055 Index Fund||0.08%|
|SWYNX||Schwab Target 2060 Index Fund||0.08%|
Always look at the expense ratio before buying
There are target-date funds that have the principles of target-date funds (i.e., an asset allocation that becomes more conservative over time), but use actively-managed mutual funds instead of index funds. These funds can be much more expensive than target-date funds that use index funds. Look for a target-date fund with an expense ratio less than 0.20%, such as those offered by Vanguard, Fidelity, or Schwab.
Step 3: Assess your retirement age
The next thing you need to decide is your expected retirement age. For example, if you are 32 years old and plan to retire at age 65, then a target-date 2050 fund would be most appropriate.
However, if you are planning to retire earlier, then you should pick an earlier target-date fund. For example, a 40-year-old investor who plans to completely retire from clinical medicine at age 50 might want to use a target-date 2030 fund.
Step 4: Use automatic contributions to consistently contribute to the account
Keep on investing money into the target-date fund. Ideally, you should automate this process so that a portion of each paycheck goes into investing.
Picking a target-date fund can be daunting for new investors, but with a little planning, it’s not as hard as it looks. A target-date fund can be a great starting point, or an investment you hold for your entire career.
“Wall Street Physician,” a former Wall Street derivatives trader , is a physician who blogs at his self-titled site, the Wall Street Physician.
Image credit: Shutterstock.com