You’ve been investing in your 401k for quite some time and are probably still clueless in where your money is going. (Dont worryyoure not alone)
But you’re thankful that they offer these target date or life cycle funds that make investing in your 401k so easy.
Winner, winner, chicken dinner..how easy is that?
Here’s the BIG problem. Target date funds, although easy, can sometimes eat away at your returns.
Or stated just a bit more bluntly They suck!
*You know I hate Target Date Mutual Funds when I take the time to record a video. Target date funds were created to take away the hassle of having to research the mutual funds in your 401k and build and construct your own portfolio. But in my experience, taking the time to do the research and, essentially, build your own target date funds in your 401k, is a much better option. It’s this a la carte approach that can potentially give you much higher returns over your working life.
What Makes Target Date Funds so Bad?
First, lets understand how they work. Most often these funds are created by a specific mutual fund company. Then that mutual fund company will take 12-18 of their mutual funds and create this diversified portfolio on your behalf. As you age towards your target date of retirement, the 12-18 funds will start shifting to something more conservative (movi.ng from less stocks to more bonds)
Sounds like win-win, right? You would think. Heres the problem.
When you start breaking down the individual mutual fund options inside these target date funds, you start to uncover that there are some or several of these funds that are just plum horrible.
What Ive Seen With Target Date Funds
Over the years, I’ve seen countless target date mutual funds that my clients have brought in and thus far, I haven’t seen one that I’ve been impressed with.
Recently, I had three different clients bring in their 401(k)’s, all of which having target date funds.
Show Me Some Examples
Here’s some examples of three clients’ 401(k)’s where we compared the target date portfolio and looked at their ten-year returns, we adjusted that for inflation, and see how that compared with the new portfolio.
Now, keep in mind, the new portfolio consisted of the mutual fund options that were available to them in their 401k.
See, whenever you have a 401k, the target date fund is usually the easiest option, and sometimes your default option, but you typically have the ability to go in and create your own portfolio. Most people dont because they simply just dont know and dont feel comfortable doing it.
I cant blame people for not feeling comfortable or qualified to do so. Im hoping by showing you some numbers below that youll at least consider it. Lets take a look..
Sample Client One
With each client we kept the ratio of stocks and bonds relatively the same. As you can see, the first portfolio netted a 3.61% more return over a 10 year period. 3.61%! Remember, we are just using other mutual funds that are already in the 401k.
Target Date Portfolio4.22%.79%.90New Portfolio7.83%4.28%.76Difference+3.61%+3.49%-.14
For the super analytical people, I had to include other factors as beta, standard deviation and alpha. If you dont know that means, its OK. You dont need to. What you may be more interested in dollars.
Target Date Portfolio14.831.33New Portfolio12.804.79Difference-2.03+3.46
What does 3.61% really mean over the long term? Well, lets just say A LOT. As you can see below, in 5 years on a $100,000 portfolio, its over $22,000. Wow! And as you can see it only gets bigger and BIGGER.
Target Date Portfolio$122,958$151,186$228,571New Portfolio$145,780$212,518$451,640Difference$22,822$61,332$223,0069
Those numbers dont really reflect what happens in a 401k. If you have a 401k, then most likely youre adding to it on per paycheck basis.
Using the same returns, I wanted to demonstrate if you were adding $5,000 per year into it. As you can see the 20 year number is a $295,000 difference. Okay, that deserves a special call out
The 20 year difference is $295,000! Wowzers.
Target Date Portfolio$150,159$211,832$380,907New Portfolio$175,014$284,369$676,186Difference$24,855$72,537$295,279
Sample Client Two
You can go through the rest of the examples and see more of the same. Whats the recurring theme? You guessed it. Target date funds suck.
Target Date Portfolio7.00%3.48%.69New Portfolio9.80%6.19%.72Difference+2.80%+2.71%+.03
Target Date Portfolio11.714.04New Portfolio12.576.66Difference+.86+2.62
Target Date Portfolio$140,255$196,715$386,968New Portfolio$159,592$254,697$648,704Difference$19,337$57,982$261,736
Target Date Portfolio$169,009$265,797$591,945New Portfolio$189,996$333,624$928,656Difference$20,978$67,827$336,711
Sample Client Three
Different Client. Different 401k. Different target date mutual funds. Same sucky results.
Target Date Portfolio5.55%2.08%.98New Portfolio7.78%4.26%.89Difference+2.23%+2.18%-.09
Target Date Portfolio15.962.59New Portfolio14.804.72Difference-1.16+2.13
Target Date Portfolio$131,006$171,626$294,554New Portfolio$145,442$211,535$447,470Difference$14,436$39,909$152,916
Target Date Portfolio$158,939$236,153$469,828New Portfolio$174,647$283,215$670,779Difference$15,708$47,062$200,951
Managing Your Own 401k
Now, I understand that most people don’t know what the heck they’re looking at in their 401k, so it’s hard for them to do their own research, but that’s where a financial planner comes into play.
Find an advisor that knows that they’re doing and have them construct you an optimized 401k portfolio. Even if you have to pay that person $1000 to help with your 401k, that $1000 is nothing, especially when you look at the numbers above.
401k Review Service
Since I realize people need help with their 401k, it only made sense to include that as a part of my practice. Dont worry, its not $1000. If you need help with your 401k, check out my 401k review service.
Need help with your 401k?
If youre struggling to make sense with your 401k, stop going at it alone. Read more about my 401k review service to get your retirement on track. Click here to learn more.
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