Although I invest a lot of money for retirement, I'm not very interested in spending time building the perfect portfolio. I own very few individual stocks, I don't enjoy researching companies, and I don't like keeping close tabs on what my investments are doing.
Despite this, there's one type of investment that I'll steer clear of even though it might seem -- on the surface -- like the perfect choice for my needs.
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Target-date funds appear to be a good option for hands-off investors
Based on my aversion to devoting time to investing, you might think I'd be the ideal candidate to buy a target-date fund, because they're specifically designed to simplify the investing process and make it totally hands off. You simply pick a specific fund that matches your preferred retirement year (such as a 2040 or 2050 target-date fund), and then your money is put into an appropriate mix of different assets based on your timeline.
With target-date funds, your portfolio is also rebalanced over time as you get closer to the date you'll retire and need your investments to produce income. You don't have to manually monitor whether you have the right investment mix because everything is done for you.
3 reasons I'll steer clear
Although target-date funds would allow me to pick my investments once and do absolutely nothing after that, there are three big reasons why I won't put my retirement money into them:
- Higher fees: Investors in target-date funds pay both indirect fees for the underlying investment vehicles the fund buys, as well as direct fees for management. Fees tend to be higher than on exchange-traded funds (ETFs), which simply track financial indexes. Higher fees reduce real returns substantially over time.
- Reduced returns: According to a 2020 study, most target-date investors are complacent and don't reward fund managers for good performance by investing more or punish them for poor performance by switching funds. Because they aren't held accountable, managers don't have the incentive to maximize returns, and typical investors who hold their positions for 50 years face a 21% cumulative-return loss.
- They may not provide the ideal asset allocation: Although there are basic rules of thumb for deciding what mix of assets to use based on your investing timeline, individual investors may want to personalize their asset allocations based on their own levels of comfort with risk. You can't really do this with target-date funds.
Here's what I do instead
The downsides of target-date funds simply aren't worth it for me, especially since there's a very simple alternative that doesn't take me much more time. Instead of buying them, I've built a portfolio full of ETFs. I then pick my specific exposure to a mix of different assets including stock shares for large, mid-size and small companies, as well as bonds and real estate. And with fund screeners available through my brokerage firm, it took me only a few minutes to find each one after assessing their fees, goals, and past performance.
I do need to rebalance my portfolio each year as I get closer to retirement by reducing how much of my money is in higher-risk funds (such as emerging markets and small-cap funds) and moving some of my assets into safer investments like bond funds. But this takes less than five minutes once a year.
If you're a hands-off investor like me, don't automatically assume a target-date fund is the best choice for you. Consider whether you'd rather pay high fees and give up potential returns or prefer spending just a few minutes each year putting together a portfolio that better meets your needs.
