Too Smart for a Target Date Fund?

A few months ago I was faced with a question that I had never thought about before:  How should I be saving for retirement?  I had just landed my first full time job and knew that I wanted to put away a good portion of my income for retirement.  I just didn’t know how – or even how much.  My benefits orientation on the first day at work was not much help.  The only thing I learned was that the default investment for the company’s 401(k) contributions was a Fidelity Target Date fund.

At the time I thought, “I’m way too educated to be investing in a target date fund.”  In case you didn’t know, a target date fund is a mutual fund that automatically diversifies each share into stocks and bonds, and changes that mix (more bonds less stocks) as you get closer to your retirement.  The simplicity and ease of investing in a target date fund seemed to good to be true.  And so I embarked on a quest to find the smartest way to invest in my IRA.  After a month, I had read 5 books and parts of many others.  I read a bunch of articles, many sent to me by my girlfriend who knew I was frantically searching for answers. I even made a few of my own spreadsheets.  The result of all this research? I bought shares in a target date fund.

I’ve divided the journey into 7 parts (different posts) to help explain the logic behind my conclusion.  A brief summary of part is included below:

Part 1 – Individual Stocks and Retirement Portfolios: Investing in individual stocks takes too much time, causes stress because of the high stakes, and generally results in underperformance.  I decide to never invest in individual stocks in my retirement portfolio.

Part 2 – The Case Against Mutual funds: It turns out that mutual fund managers can’t beat the market either.  I decide that I will buy index funds.

Part 3 – Asset Allocation: A proper retirement portfolio will not have all its assets in just one index fund, it needs to be diversified.  I decide on a proper asset allocation for my age and begin the search for the 10 index funds that will leave me properly allocated.

Part 4 – Expense Ratios: There are many index funds that have the same holdings, but low expense ratios are what set the good ones apart.  I find out just how important expense ratios are and pick out the index funds with the lowest cost to me.

Part 5 – Account Fees and Commissions: Funds with low expense ratios aren’t so good if you have to pay a transaction fee or commission every time you buy one.  I decide to find the cheapest broker and limit the number of purchases I make per year.

Part 6 –  Portfolio Rebalancing: Buying funds only once or twice a year causes you to miss out on the power of rebalancing and end up with a poor asset allocation while you are waiting to buy more funds.  I decide to revisit target date funds.

Part 7 – The Solution: I find out what holdings actually make up the target date funds and compare their expense ratios.  It turns out that target date funds have many benefits over any other funding strategy: low transaction costs, low expense ratios, and low stress.  I buy a target date fund.