Many people invest their 401K contributions in Target Funds based on their planned retirement year. Target Funds are composed of different financial instruments like stocks, bonds, commodities. They claim to have a magic formula which calculates what percentage of your contribution should be allocated to each asset. By this approach they mitigate risk against any market crashes.
I have invested in Target funds during my initial years and soon realized that there is no data to support the claims. It is just the fear taking over logic. My conclusion was during Bull markets, Target fund is going up by less compared to the market and during stock crashes, it will go down less compared to the market. It didn’t make any sense to me. I don’t win big during up market but lose mediocre amount of money during down market.
Here is an exercise to prove my point, check various target funds in your 401K account. You will notice the following
- Most of the actively managed and target funds available are from the administrator.
- The expense ratios are higher compared to cheap Vanguard funds
- No data on how the portfolio performed during 2000-2003 or 2008-2010(Market slumps).
- No clear information on fees, dividends or risk mitigation of the portfolio for Target Funds.
Some 401K administrators don’t provide you with cheap vanguard funds to invest in but their own index fund whose expense ratio is way higher than that of Vanguard. I had this problem with a plan administrator, plan admin’s S&P500 index fund was available but the expense ratio was very high, probably 10-20 times that of the Vanguard equivalent. There were plan admin’s very own various actively managed funds, Target funds available. Luckily there was one Vanguard fund which was income fund and NOT index fund. I took it for the following reasons.
| Plan Admin’s Target Fund | Vanguard Income Fund | |
| Expense Ratio | 0.48% | 0.18% |
| Composition Details Available | Partial details. | Yes. Complete details. |
| Return for 2019 | 16% | 21% |
| Dividend Yield | 0 | 2.5% |
| Performance Data YoY | Not Available | Available on internet |
Based on this information I decided to invest in Vanguard’s Income fund which was available. With this I could track not only how the fund is doing now and historically but also of any changes.
Once retired smart investors withdraw small pieces of the fund based on their requirement. I am yet to come across someone who withdraws the whole fund in one shot. When market goes down you want your dividends to buy the units at cheap so that they go up when market does.
Logic & Wisdom Over Fear!
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