Are Target Date Retirement Funds Good?

If you’ve ever owned an IRA or company 401(k), you’ve probably had experience with some sort of Target Date Retirement Fund. While those funds are okay, I don’t think they’re ideal.  In this article, I’ll explain why.

In short, target date funds will not get you the returns you’re looking for because they hold investments in poor performing stocks and bonds — this will hurt your overall return — and those investments won’t do as good as the overall stock market.

Let’s look at all the reasons in detail.

1. They adjust overtime

I used to think that a fund that automatically reallocated assets overtime was a good one.  However, I don’t think that anymore.

Target date retirement funds start out primarily in stocks, and automatically reallocate investments towards bonds overtime.  That sounds great in theory, but it’s really not the greatest option when you think about it – here’s what happens.

When you are far from retirement, you are investing in stocks (which will get you way better returns than bonds).  As you get closer to retirement, these target date funds start to allocate more money towards bonds in an effort to conserve your growth.

However, when you conserve your growth by putting more money towards bonds, you will also conserve your returns – so you won’t do as well.

Some think this is a “safe option” (or more conservative), but it’s only a small step above giving up – it’s only a small step above sitting on a pile of cash that earns no interest!

The point is this – that money could still be getting good returns if left in a stock heavy portfolio.

Is this risky?  Well, that depends on what you mean by risk.

When you get to retirement, you should be paying yourself modest distributions to live on – not the full amount.

If you lose 20% one year, but gain 40% the next year, that’s still a net increase of 20%.  By leaving your money primarily in bonds, you won’t get that kind of return.

You see – you’re not going to be taking all of your money out at once – this money is supposed to last you until you die (and beyond).  Hopefully, you will still have money left when you die to pass on to your kids and such. The goal should not be to spend all that you have, so leaving your money invested in stocks (still averaging great returns) is a better option than moving it over to bonds (where your returns are stifled).

When you invest in a target date retirement fund, you are going to have a fund that reallocates your investments as you approach retirement – it does this automatically.  While that is not a terrible idea, it’s not the best either – it will hurt your overall returns, causing you to have less money to live on and pass down to others.

2. They invest in bonds

It’s no wonder why target date retirement funds don’t perform as good as the market – they invest in bonds.

Bonds are not going to get you the kind of returns you see in the stock market.  There is no bond fund (that I know of) that will get you and average return of 12% – this is what the stock market has done historically.

If you have a fund that allocates money to bonds (whether foreign or domestic), your returns are going to suffer for it.

For example, one of the first funds I had when I started my Roth IRA was Vanguard’s Target Retirement 2050 Fund.

It was basically a “fund of funds” – one fund made up of four different Vanguard Index Funds (one really good one, and three not so good ones). It was made up of two bond funds (one foreign and one domestic) and two stock funds (one foreign and one domestic). Here is a breakdown of that fund:

The 4 funds in vanguard’s target retirement 2050 fund

Remember – those percentages automatically adjust overtime.

For now, let’s see how the bonds have performed against the S&P 500 (or actual market) over the last 10 years.  We’ll look at the international bond fund first:

Vanguard total international bond index fund vs S&P 500 index

As you can see, the international bond fund is getting destroyed by the actual market.

What about the domestic bond fund?  Here’s how it matches up:

Vanguard total bond market index fund vs S&P 500 index

No surprise, it gets destroyed by the market too.

The fact is this – whether it’s foreign bonds or domestics bonds, you’re not going to get the kind of returns you can get from the actual market.

Therefore, I don’t recommend investing in bonds at all – doing so will only hurt your returns, and that’s what will happen with a target date fund.

3. They invest in international stocks

As with bonds, international stocks generally don’t perform as good, either.

Now, it is possible to find an international stock fund that is good (or better) as the overall market, but most of the time that’s not the case – international stock funds won’t do as well.

Let’s look again at the Vanguard Target Retirement 2050 Fund and see how the international stock fund performs:

Vanguard total international stock index fund vs S&P index

As you can see, the international stock portion is also getting killed by the overall market.

Now, this isn’t always the case, but with this particular fund it is.  You don’t want to invest in poor performing international stock funds that are going to hurt your overall returns – that’s exactly what’s happening here with the Target Retirement 2050 Fund.

4. They are outperformed by the market

Perhaps the biggest reason that target date funds are not that good is because they are outperformed by the overall market.

This is largely for the reasons mentioned above, but to reiterate – it’s because they invest in poor performing international stock funds, bond funds, and automatically adjust overtime.

Target date funds are just not going to hang with the market – look at how Vanguards’s Target Retirement 2050 Fund matches up with the S&P 500:

Vanguard target retirement 2050 fund vs S&P 500

It’s not bad – it’s just not as good as it could be – because three of its four funds are hurting its overall returns.

Now, I did leave one fund out – the total stock market fund – and that’s because it’s actually a really good fund.  In fact, it’s the reason Vanguard’s Target Retirement 2050 Fund gets decent returns to begin with. When you compare the total stock market fund with the overall market, you’ll see why – so here it is:

Vanguard total stock market index fund vs S&P 500 index

They are almost identical.  The total stock market fund will get you the returns you’d expect from the overall market.

The total stock market fund is Vanguard’s VTSAX fund, and it’s a great fund.  In fact, I wrote an article about it, Why the Vanguard VTSAX Is the Only Fund You Need, if you’re interested.

Why don’t people have money at retirement?

The number one reason people don’t have money at retirement is because people don’t save for retirement – it’s pretty simple.

It’s not so much the rate of return or type of fund – it’s that you actually save.

You have to invest all you can (most financial experts will tell you about 15% of your income needs to be saved for retirement), if you want to have money at retirement.

Yes, there are funds that are better than others – funds that will get you better returns than others – but you still have to save the money.  If you don’t save the money, it doesn’t matter how great a fund you have.

If go with a target date fund and average an 8% return, or 10% return, that’s not bad – but it could be better.

If you are looking to get good returns, I would avoid target date retirement funds – there are just too many other options out there that are a way better.

Final thoughts

Target date retirement funds are a great way to get started investing, and you can do so pretty cheap. However, once you’re started, I would consider exchanging those funds for funds that will get you better returns (returns of the actual market).  At the end of the day, a target date fund isn’t going to do that, and there are better options to consider – the VTSAX is one of them.