Seven reasons to put 100% of your portfolio in a target date index fund

[system]

Originally published at: https://www.personalfinanceclub.com/seven-reasons-to-put-100-of-your-portfolio-in-a-target-date-index-fund/

I love target date index funds. I believe they’re your best bet to maximize long term wealth and almost every individual investor should put 100% of his or her equity portfolio in a single target date index fund. Seriously.

What are target date index funds?

• They’re named after a target retirement year: A couple examples are Vanguard’s Target Retirement 2050 Fund and Fidelity’s Freedom® Index 2055 Fund.
• They’re index funds: That means there’s no smart guy getting paid a lot of your money to pick and choose stocks for you. Instead, they hold the entire “index” of available stocks. Index funds have much lower fees and studies show over and over they’re very likely to beat actively managed funds over time. Owning all the stocks guarantees you your fair share of market growth.
• They’re “funds of funds”: Each is a single fund that holds inside of it several index funds. They’re usually composed of:
  • A total US stock market index fund
  • A total international stock market index fund
  • A bond index fund (may be split between US and international)
• They reallocate over time: As time goes on they move from a heavy stock allocation to maximize growth while you’re young, to a heavy bond allocation to provide income and capital preservation in retirement.

Seven reasons to put 100% of your portfolio in a target date index fund

1. Diversification: They contain thousands of US and international stocks. (9,882 different in the case of Vanguard’s 2050 fund for example). So you have the power of nearly every publicly traded company on the planet working for you.
2. Every Sector: Tech, retail, health care, transportation, energy, etc are all represented. Instead of guessing which sector to invest in, a target date index fund removes individual sector risk by owning them all!
3. Low cost: Mutual funds often have expense ratios of 1% and higher. Target date index funds have expense ratios generally around 0.15%. That may not sound like a big difference but over the course of your life it could save a quarter or more of your whole portfolio that would otherwise erode to fees.
4. Auto-Rebalancing: These funds automatically rebalance themselves so you don’t have to worry about it. International stocks are way up while the US is down? It will rebalance to stay on the target asset allocation. Regularly rebalancing mathematically improves returns over time.
5. Auto-Reallocating: As you get older, they automatically shift to more conservative investments to protect your nest egg and provide income in retirement.
6. Eliminates guesswork: Even a simple three fund portfolio can have a lot of options. How much do you put in each fund. And when they perform differently, it can be tempting to change your mind and allocation. That jumping around is likely to hurt your long term performance. With a single fund, you dump everything in it, forget about it and you’re rich.
7. Simplicity: With one fund, it makes your life simpler when deciding what to buy. This simple “set it and forget” mentality can help with bad human behavioral tendencies like chasing past performance and trying to time the market.

Throwing in more funds won’t make you more diversified or improve performance, it will just make you more likely to lose to the market over time. A single target date index fund guarantees you your fair share of the market and automatically manages risk over the course of your life.

A word of warning

Not all “target date funds” are target date INDEX funds. If you buy an “actively managed” target date fund, you’ll be paying much higher fees and will be very likely to lose to the market.

You can tell whether or not a target date fund is an index fund by looking for the word index in the name and by looking at the expense ratio. Index funds generally charge well under 0.5% (usually closer to 0.1%). Actively managed funds generally charge over 0.5% (usually closer to 1%)

So how do I buy one?

If you’re investing inside a 401k or 403b, your company may offer a target date index fund option. If not, your best bet is to buy and hold 2-3 individual index funds according to the rules on the home page, then roll over your 401k when you leave that company.

If you have your own IRA or brokerage account, then you need to look up the target date index funds offered with no load and no transaction fee by your brokerage. My favorite brokerages are Vanguard and Fidelity.

Which one do I buy?

To choose a target date index fund, first choose your brokerage from the chart below. Then take your birth year and add 65. For example, if you were born in 1980 and you use Fidelity: 1980 + 65 = 2045 (FIOFX).

Retirement Year	Vanguard	Fidelity	Schwab
2020	VTWNX	FPIFX	SWYLX
2025	VTTVX	FQIFX	SWYDX
2030	VTHRX	FXIFX	SWYEX
2035	VTTHX	FIHFX	SWYFX
2040	VFORX	FBIFX	SWYGX
2045	VTIVX	FIOFX	SWYHX
2050	VFIFX	FIPFX	SWYMX
2055	VFFVX	FDEWX	SWYJX
2060	VTTSX	FDKLX	SWYNX
2065	VLXVX

Note that choosing an earlier year doesn’t mean you’ll get to retire earlier. It just means your investment will get more conservative earlier. If you want to be more aggressive with your investment you would actually do the opposite and pick a later year, but the asset allocations they have chosen at the given dates are reasonable and being realistic with your asset allocation timeline in is wise.

[ChellH]

Thanks for posting this. A target date index fund sounds very promising. I looked into VTSAX, VFIFX and S&P 500. I know the target date index fund has a different fund make-up than VTSAX /S&P 500, as it consists of international stocks, and some bonds. So, I get VTSAX and VFIFX may not be ideal for side by side comparison.

Below is based on published data comparing the growth of a hypothetical $10,000 invested in 2010 til June '20:

S&P 500 Index - $37,030.98
VTSAX -$36,199.84
VFIFX -$26,169.17

Below are the expense ratios for VTSAX and VFIFX:
VTSAX - 0.04%
VFIFX - 0.15%

VTSAX has about $10,000 more growth and a lower expense ratio when compared to VFIFX. I understand and really, really like the idea of VFIFX automatically rebalancing and reallocating. You are right, it takes the guesswork away from me having to have the right balance of US stocks, international stock and bond fund and making sure that I make correct adjustments as I get older.

My question is, am I loosing out on potential growth if I go with VFIFX rather than VTSAX (and may be try to include some international stocks and bonds in my portfolio). Is this just too risky for me to try and do myself? Or at the end of the day, does it make more sense for me to go with a target date index fund and just assume in the future that this growth difference will be little.

Thanks! Wonderful community.

[Jeremy (Jeremy Schneider)]

Hey @ChellH!

That’s a really good question. And smart, educated, experienced, altruistic people disagree on the answer.

But first, let’s examine why VTSAX outperformed the target date fund over the last 10 years. Those ten years started right at the end of the financial crisis when the US market was super low. What followed was 10 incredible years of US stock market growth. The US market was the best performing asset class by far. A target date fund is more diversified (as you mentioned) because it also contains international and bonds, which didn’t grow as fast during that time. So the diversification basically slowed it down this past decade.

So, for the last 10 years, for sure, you would have been better off being 100% US stock market. But that’s easy to know because those charts are readily accessible. What we really want to know is what’s going to happen the next 10 (or 50) years. That’s harder to know. For example, I could imagine reading a post 10 years from now that says something like “With China, Korea, Brazil and India outperforming the US stock market by so much, why would you ever want to invest in a target date fund that contains all those old slow growth US companies?” If you weren’t in international for those 10 years, you would have missed out on that exciting growth. (The same argument could be made for a down world market and bonds outperforming).

I like having the international component, even though the most recent decade doesn’t prove my point.

Here’s a good thread on the same US vs International debate that gives a pretty good breakdown of both sides:

Investing in the international market

Hey @Nirav! Both Jack Bogle and JL Collins don’t recommend investing in the international market. I think the reasoning is as follows: It adds complexity (more funds to manage) without likely increased returns It adds expense (international funds are slightly more expensive) It adds currency risk Some foreign countries may have very weak accounting regulations that could allow fraud, or even currency manipulation Big companies in the US do so much business with the rest of the world, that ton…

But if you wanted to go 100% VTSAX I wouldn’t try and stop you. I would, however, suggest that you pick a strategy and stick with it. A lot of oscillating back and forth based on what the market is doing is likely to lead to “chasing past performance” where you go and buy what just did well, and always miss out on what’s about to do well, thus underperforming either strategy.

Thanks for the question and the kind words about the community!

[jnelmo (Janelle)]

Thank you so much for this post! I like the idea of target date funds for the convenience of rebalancing and reallocation. I do have a question. If my 401(k) is with Vanguard 2055, but I’m targeting to RE closer to 2045, would maxing my Roth IRA in a 2045 fund be beneficial/wise?

[Jeremy (Jeremy Schneider)]

Hey @jnelmo!

In my opinion, no. Stick with the 2055 fund. It has more to do with how long you’re going to live than when you stop working. And if there’s one fair critique of target date funds, it’s that they get too conservative too early. You can fix that by simply picking a later date, so your portfolio stays more stocks for longer. I think if you never invest a penny in anything other than the Vanguard 2055 fund, you will do great!

[CoachMatt (Matt)]

Working in schools and universities I have had to put my retirement into the hands of TIAA. I have always done target date index funds. When I looked at the expense ratios on them they are between .4%-.6%. I have a Fidelity account with a Roth IRA and a brokerage account. I have been thinking about switching my TIAA investments to an S&P Index Fund (TISPX) and and Equity Index Fund (TIEIX) that have expense ratios of .05%. Then I would put all my Roth investments into Fidelity Target Date Index Funds with their lower expense ration of .12% compared to the .4%-.6% of TIAA’s Target Date Index Funds. Good strategy or am I overthinking it? Haha. Thanks for all the great information you put out!

[ChrisAtTTL (Chris)]

As long as the TIAA vs Fidelity target date funds have a similar mix of assets (and presumably a similar year target), it doesn’t sound like there’s much you’d lose—except that higher expense ratio cost.

Fidelity also offers a great Total US Market Fund (comparable to Vanguard’s VTSAX) with ticker FSKAX. That’s a bit more diversified than an S&P 500 fund.

[Will_Lu]

I currently have a 401K and a Roth. The 401K is invested up to what my company will match and is put towards a Target Date Index Fund. I know I can save more and hit the annual max contribution for my Roth. If I have the option to invest in both, should they both be in a Target Date Index Fund?

[thberry10 (Tom Berry)]

Yes, TDIF’s are fantastic. Other alternative would be to manage your own 3 fund portfolio if you want to customize your asset allocation, but the TDIF does this and rebalancing for you. Just stick with the TDIF

[TurbulentHarpist (Ari)]

Great information! Checking through my options, I noticed that the fees for Schwab target date index funds are significantly less than Fidelity and Vanguard. I wonder why that is? It gave me pause because it almost seems too good to be true. Any thoughts on this? My guess is that Schwab is trying to entice target date fund shoppers to switch providers.

• VFFVX: 0.15% Net Expense Ratio
• FDKLX: 0.12% Net Expense Ratio
• SWYNX: 0.08% Net Expense Ratio

[Ramiel_Coleman]

Great information on Target Date Index Funds. I do have one question.

I am 25 years old and am going to begin my investing journey rather soon. If I decide to invest simply in one Target date index fund when I decide to stop working, can I sell what’s inside it little by little, or well I have to sell it all at once?

[stacyL]

@system

Actively managed funds generally charge over 0.5% (usually closer to 1%)

I have some of my money of my Roth IRA contributed to an actively managed funds (charges 0.67%). Would you recommend I sell it and put all my 2021’s contribution money in a target index fund?

Are there any pros to having an actively managed fund or having some money in an active fund and some in a target index fund?

[ellenbugni (Ellen)]

Great material!!! I am leaning towards target index funds too. Is this the fee for fidelity?
Thank you

[Jeremy (Jeremy Schneider)]

Hey @ellenbugni!

That’s a target date fund, but not a target date INDEX fund! Fidelity confusingly offers both and you’re looking at the one with about 6X higher fees!

The 2035 target date INDEX fund ticker symbol is FIHFX.

Read the “Word of warning” and see the ticker symbols at the bottom of this article!

Seven reasons to put 100% of your portfolio in a target date index fund

[Jeremy (Jeremy Schneider)]

That’s what I would do. No pros in my opinion to having an actively managed fund, but people who profit from those funds would disagree

[Flambeau21 (Rashaun)]

so I have the target date fund in my vanguard 401K, and target date fund in my Schwab Roth. So, I should switch my 3 fund portfolio in my brokerage
to a target date fund also? New to investing.