Posted by My husband recently changed employers and as the household CFO, I wanted to know everything about his new company retirement plan.
I was super excited to learn that his employer had a very generous program. No waiting period to participate! 100% matched retirement plan (up to a certain percent)!
As we went through the steps to set up his plan, we ended up at my favourite step in the process – picking the funds to invest in. With his prior employer’s plan, we selected low-fee funds that tracked the Canadian, US and Global indices. Across all of our investment accounts, we pick a similar asset allocation for balancing purposes.
When flipping through his new employer’s program, I was disappointed that there were very few funds to select from. There was only one option for each of Canadian, US and global equities. So I dug further into each fund’s fact sheet and underlying investments. I was even more disappointed that they were high-fee funds at 2-3% with active investment mandates. Some were “targeting to exceed benchmark indices by 2%”. Yikes.
Unless Mr. LJ invested in high-fee actively managed funds, there wasn’t any way for him to replicate our target asset allocation. Aside from those options, there was a list of “target date funds” with dates in 5-year increments, from 2025 through to 2050.
What are Target Date Funds?
Target date funds are funds where the strategy is to adjust the bond/equity allocation to reflect to the desired retirement date. As the fund gets closer to the target retirement date, the portfolio allocates more to bonds and becomes more conservative.
Why use Target Date Funds? For simplicity!
When looking at company retirement or pension plans, here’s the three ways of selecting investments, ranked from easiest to hardest:
- Target Date Funds: Out of the list of Target Date Funds, find the fund dated closest to your retirement, and voila. You’ve made your investment selection. It can take less than 5 minutes to make this choice.
- Investor Questionnaire: Answer a series of questions about your personal preferences and risk tolerance. It can take between 5-15 minutes, depending on the survey complexity. At the end, the questionnaire will make a recommendation for what you should invest in.
- Active Portfolio Selection: Review the full list of investment options, understand the objectives and investment profiles of each fund, and select the funds to invest. If you select more than one fund, you’ll also have to figure out how to allocate your money across the various funds. It would take at least 30 minutes to comb through the fund options. Then add on however long it takes for you to figure out how to proportionate allocation in the funds. The average person may have given up at this point.
Which Target Date Fund should you pick?
The basic answer would be: “pick the year that you’re expecting to retire in!” Target Date Funds are just that simple to use!
As we looked at the options for my husband, we did not simply pick the date closest to his retirement year. Since our goal is to reach financial independence by our mid 40s and retire by mid 50s, we looked at the underlying equity/bond allocation % within each Target Date Fund. We selected the fund where the equity/bond allocation was closest to our target asset allocation.
If we picked the Target Date Fund closest to our desired retirement of mid 50s, it would mean a fund about 20 years out, or roughly 2040. The asset allocation of a 2040 fund was roughly 10-15% bonds and the rest in equities. Since our target asset allocation is 100% equities, the 2040 fund didn’t fit our needs.
Ultimately, we chose the Target Date Fund in 2050. It was the fund closest to 100% equities.
Watch out for high fees and active management
As a last check, we confirmed that it was a low fee Target Date Fund of ~0.2%. The underlying investments consisted of index funds. Both of these fit our investment principles of investing in low-fee passive investments.
There are Target Date Funds where it’s based on active management, which leads to high fees. I generally steer clear of actively managed funds of any kind, as there’s no guarantee of outperformance. Add on the higher fees and it might lead you to underperform compared to a passively management Target Date Fund.
Review annually to see if the Target Date Fund still makes sense
One of the main benefits of Target Date Funds is “set it and forget it”. For the average investor, this is helpful, as it requires less effort and frees up mindspace to live their life.
As portfolios grow to 5- or 6-digit values, I don’t think it makes sense to leave portfolios without touching them forever. At least once a year, review your company retirement portfolio to see if it still makes sense:
- Did the fees go up?
- Did the underlying investment profile change?
- Is the glidepath or asset allocation still relevant for you?
- Have you changed your retirement date?
- Does the company plan’s value and asset allocation fit into your broader portfolio outside of the company plan?
- Does your company plan now offer new investment options that might be better than the Target Date Fund?
Overall, Target Date Funds are a good option for the average investor. I would still prefer to invest in separate low-fee passive index funds for my husband’s retirement plan. Since that option was not available to us, Target Date Funds were a suitable alternative option.