Why Ramit Sethi Recommends TDFs to His Own Family

The "I Will Teach You To Be Rich" author highly recommends them, but not everyone is in agreement.

Most of us have probably heard about how important investing is. The stock market is arguably the most proven way to build wealth, so it's a great place to grow your retirement savings. But this doesn't mean you need to pick stocks yourself, and in fact, there are much simpler options available.

Financial advisor Ramit Sethi usually advises people to take the simple option. For that reason, his investment of choice is target-date funds, or TDFs for short. He even says that he recommends them to his family. Here's why he likes them.

How target-date funds make it easy for investors

Building an investment portfolio from scratch is a time-consuming process. It takes about 20 to 30 stocks to have a diversified portfolio, which is when you're not too reliant on any single company. In addition to finding stocks, you'll also need to manage your portfolio by deciding when to sell investments and adjust your asset allocation. That could be a lot of work, especially if you're new to investing.

A target-date fund is an investment that does all that work for you. This type of fund is built around a specific retirement year, and it designs a portfolio for you based on when you want to retire. For example, if you want to retire in 2045, you could invest in a 2045 target-date fund.

These funds handle asset allocation for you. When you're decades away from retirement, a target-date fund will invest heavily in stocks, since they offer more growth potential. Your portfolio will gradually transition to more conservative investments, like bonds, as your selected retirement year gets closer.

When you invest in a target-date retirement fund, all you need to do is transfer money to it. Most good stock brokers will also let you set up recurring transfers, so you can contribute automatically. You get a diversified portfolio that will have you on track to retire when you want, with zero work required on your part.

The argument against target-date funds

While Sethi is a fan of target-date funds, there are also those who feel this type of investment isn't the best option. There are two downsides people typically bring up: expense ratios and suboptimal returns.

An expense ratio is the fee you pay for an investment fund. To be honest, this isn't a serious issue. Although target-date funds are known for having somewhat high expense ratios, these have decreased in recent years, and there are plenty of low-fee options available.

Suboptimal returns are more of a problem, particularly for retirees. Target-date funds generally get very conservative in retirement, which limits growth. A more even split between stocks and bonds offers greater growth while still providing plenty of security.

Some also argue that target-date funds aren't ideal for young investors. Target-date funds invest heavily in stocks early on, but they also invest in bonds. If you're still in your 20s or 30s, you could go all-in on stocks and rebalance your portfolio later. There are plenty of exchange-traded funds (ETFs) and mutual funds that only invest in stocks. Your portfolio will be more volatile, but it could also grow more.

Is a target-date fund right for you?

A target-date fund is a great choice for most investors. While they may not fit every investor's preferences, they don't have any glaring flaws. If you're looking for a retirement plan you can set up, automate your contributions, and leave alone, then target-date funds will fit your needs.

One thing to keep in mind with a target-date fund is that it's not ideal if you plan to make other investments on the side. It's designed to serve as your only investment, and the portfolio it builds is based on that assumption. If you add other investments to the mix, then your portfolio won't be balanced as intended.

If you want more flexibility and control, there are other ways to invest. But Ramit Sethi is correct that target-date funds are one of the best options available for straightforward retirement saving.