050 PFFAP-PYP-23-0628-Spotting Bad Target Date Funds
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Welcome to the Physician Family Financial Advisors podcast, where physician moms and dads like you can turn today's worries about taxes and investing into all the money you need. Retirement in
Nate: college. Hello, physician moms and dads. I am Nate Reineke, certified Financial Planner and primary advisor here at Physician Family Financial Advisors.
Today we are going to talk about target date funds and how you can spot the bad ones. If you don't know what a target date fund is, that is okay because we brought on a special guest today who's gonna help us understand what they are. If they are right for you and how to select great ones. That special guest is one of our very own.
Kyle Helsley. Kyle, thank you for joining us today.
Kyle: [00:01:00] Happy to be here. Thanks for having me.
Nate: Yes. So Kyle, you're certified financial planner as well, advisor here at Physician Family, but can you tell our listeners just a little bit more about yourself, uh, introduce yourself a bit more.
Kyle: Yeah. Um, I'm, uh, Oregon.
Born and raised. I went to the University of Oregon and graduated with a science degree, go Ducks. Nice. Uh, stayed in Eugene. Still live in Eugene. Uh, married with three kids. I have three girls, a seven year old, a four year old, and a one-year-old. Keep us very busy. When I got outta college, I thought I was gonna be a forensic scientist and I actually worked for a police department doing crime scenes, but that work was very tough.
It took a toll on me and, uh, I wasn't very conducive to having a family. And so, uh, I made a change and I went to work at a credit union. And I did a lot of loans and debt, and that didn't really fit in my values. And so I started looking into personal finance for people who want to save and, and get ahead and do [00:02:00] what's best, uh, for them and their families.
And so, um, I, uh, Started looking for jobs and I got hired by physician family eight years ago, and I've worked through multiple positions here, and I'm currently the retirement investing specialist advisor. Mm-hmm. Which means I work with clients on their retirement accounts and their retirement investments.
Nate: Right, okay. Which is exactly why we're having you on, because target date investing is really a strategy a lot of times target date investment strategy, or at least a target date fund. It really belongs in a physician's 401k or 4 0 3 B, is that right?
Kyle: They're really common in those types of accounts because the investment selection is limited.
It's a, mm-hmm. It's a list that's picked by a trustee of the 401k, and it's a great choice to have in a, because, um, It gives you lots of diversification and, uh, how's helps you pick a target in the [00:03:00] future. And it's a one fund solution, so it's, you get a lot for it in your limited lists on your 401k, and it's a great solution for people who maybe don't have a lot of investment acumen, but they mm-hmm.
The target day. Great. Choice for those types of people. So it's really common in 401ks and 4 0 3 Bs,
Nate: right? But I want to be real clear, uh, for the audience that many times a target date fund is available outside of 401k, but you, you know, if you're investing in like a taxable account, a lot of times we don't recommend them.
So we're mostly talking today about inside of your accounts at work. The target date funds that are usually available, it'll literally say target date, you know, 2055 or something. We're trying to analyze whether or not those funds inside of a 401K or 4 0 3 B are good at, at work for you. That's kind of what we're looking at.
First and foremost, you kind of, you kind of just said it, but [00:04:00] uh, target date investing is sort of a strategy. Different than sp a specific target date fund. Right. There's target date investing as a strategy and target date funds, which is how you implement the strategy. Can you, can you tell me the difference, like what is the, what is the strategy of target date
Kyle: investing?
Yeah, so you're making a really good distinction there. You have your investment strategy, which is your overarching. Guidelines that you're following on h how you're investing and mm-hmm. Um, that isn't necessarily always gonna be target date. That's one of the options. Um, a good, a good example of another strategy would be a static strategy where you're targeting a fixed allocation of.
Of stocks and bonds. So for example, 80% stocks, 20% bonds. That never changes. You're always gonna be 80 20, and that's what you're always targeting. Uh, target date investment strategy is one that changes over time. The idea is that you're approaching this target in the future, in this case retirement, [00:05:00] and, uh, it's.
The risk is decreasing over time. It's not fixed at that this 80% stocks, 20% bonds in the previous example. Mm-hmm. It's actually changing and getting less risky such that you have the right appropriate, you have the appropriate amount of risk at any given time between now and your goal. That's the beauty of target date investing.
And that's why, uh, if you have, if you identify your strategy as target date investing, and that's the strategy you're pursuing, I. As your overarching strategy, then it would make sense for you to invest in a target date fund because that would line up with your strategy. I see. If you're a static investor targeting a fixed allocation, that target date fund is gonna, that mutual fund is gonna change allocation, and that doesn't fit in your strategy, so, mm-hmm.
Having your strategy identified first is important into whether you want to even use a target date fund or not.
Nate: Right. Okay. So, um, How common are target date funds in [00:06:00] 401K and 4 0 3 Bs? Like do should most people expect to see one
Kyle: in the modern investing world? Target date funds are prevalent. I mean, I see them, um, in, I would say 90, 95% of the doctor 401ks and 4 0 3 Bs I look at mm-hmm.
With clients. Um, there's almost always a lineup of target date funds. Um, But alongside those target date funds, there's also always a lineup of. Uh, just regular old indexed mutual funds, you know, like a total US stock fund, a total international stock fund, a total bond fund, something like that. So you usually see those two types of mutual funds, the target date, and the, and the index funds on one list because they compliment each other.
Because, uh, if you don't wanna do target date investing, then you have these other index funds to choose from.
Nate: I see. Okay. Okay. And we're gonna get into that a bit, but, so you have two [00:07:00] options. It sounds like it's very common target date and, and, um, just se separated, you can choose your own index funds and build your own portfolio.
Before we get into like how to, how to choose the good from the bad, generally, do you think target date investing's a good idea for physicians inside of their workplace accounts?
Kyle: I do, I think target date investing is a, is an elegant solution, um, for most investors. And I think especially so for physicians.
You know, there's, with static investing for example, you're choosing a, a fixed target, like 80% stocks, 20% bonds. Uh, that's a great strategy when you're young, but as you get closer to your, your retirement age, you don't wanna be carrying that much stocks with you. And so at some point you have to consciously decide to change your strategy to something more conservative, like 60% stocks, 40% bonds, and then you have to place trades and rebalance your portfolio and, and essentially, [00:08:00] Reduce your equity exposure by 20%.
Um, that's a, that's a fairly big move to make target date investing keeps you at the right target. Stock allocation and bond allocation every step of the way so that if you're 20 years out, you're 90% stocks. If you're 15 years out, you're 80% stocks. If you're 10 years out, you're 70% stocks such that right when you get to retirement, you have the appropriate amount of stocks and bonds.
Right. When you're about ready to hang up your practice and you need your retirement savings the most, and you can't risk a giant stock market correction. Mm-hmm. So, because physicians are so busy, especially physicians with kids and families, target date is great because you, you, you put your money in and you don't have to worry about it.
You check the box on do I have the right amount of risk, do I have the right amount of diversification? Uh, all that in, in a good target date fund, all those boxes get checked for you and I see. And so you don't have to keep your hand on the wheel all the time with your investment.
Nate: Yeah, that makes a lot of sense.
I, I, I [00:09:00] also, I, I, you know, you, you are very in the details on these investments, and I'm sort of looking at this with the physicians we work with, uh, at a high level. And something I hear from them all the time about when they get into, like, the allocation is their feelings versus their goal. So they may feel like they're willing to take more risk, but when you look at their goal, Their goal doesn't, at least, theoretically, doesn't align with the amount of risk that they might be willing to take.
Right? So maybe they're five years out from retirement and they want to be a hundred percent stocks, and that just doesn't make a whole lot of sense. I mean, theoretically the market could dip and then all of a sudden your retirement's in danger. And so what I'm hearing from you is that these target date funds take care of all that and sort of take the human element out of it.
And, uh, that seems to be a healthy. Balance for, for the physicians we speak with. Would you agree?
Kyle: Yeah, definitely. Um, okay. [00:10:00] It's, it's those, uh, decisions to adjust allocations off based off of a feeling or to increase or decrease risk based off of feelings. That's usually when mistakes are made. I agree. Uh, and so target date investing, uh, if you have the fund company that you trust and you've looked at the fund and it's, you like it, then.
You shouldn't have to worry about those things.
Nate: Yeah. Okay. So that, that brings us sort of to our, to our, we're getting into really the point of this topic. We've set the stage a little bit here, but um, it's easy to say, go in and just select the target date fund. The target date fund, cuz usually there's one or at least a list.
So for listeners who. Who haven't looked at closely into this, or don't know, maybe they haven't started investing yet. When you go into your 401k, there should be a bunch of options where you select the year you'd like to retire. The closest thing, sometimes they're in five year increments. [00:11:00] You select the year that you would like to retire, and then you just are putting all your money in that fund, and it's rebalancing according to how close you get to that date.
And that sounds relatively easy, and it is, but the question is, Does it matter when you get inside of your 401k or 4 0 3 B, what options you're given? Like what you, you click the target date fund, but are, are there different target date funds? Are they all like made up of exactly the same thing?
Kyle: It absolutely does matter which target date fund you're investing in.
Um mm-hmm. This, if you have the same employer and you're just starting to save, you could be investing in the same fund for 30 years. Uh, that's a huge commitment. So you definitely want to, uh, make sure that. It's, it's a good fund. Um, as I like to say, not all target date funds are created equal. There are a whole array of target date funds out there from multiple fund companies, and sometimes there's different target date funds within one fund company.
They'll have different share classes, they'll have different strategies. Um, I've seen aggressive target [00:12:00] date, moderate target rate, and conservative target date funds. All at one fund company you have three choices, so it certainly does matter. Which one you're choosing because you don't want to commit to a fund that is, that is not a good fund, that is a poor fit.
Nate: Right. Okay. So take us into your world a little bit. Like how do you actually, when you're looking at which fund of physicians to choose, how do you identify like good from bad? Like describe what a good target date fund looks like.
Kyle: Yeah. So I'm gonna talk about the good and the bad. Okay. I can put 'em right next to each other.
So I'm gonna go through a list of kind of the, the things that I think about. And then when I think about these things, I want to find the information about these things and okay. And, and make a decision based off of the collective information I've got gathered. So one of the first things I look at is, is it passive or is it managed?
So, Um, passive is [00:13:00] like using index funds. It's not, there's always a fund manager, but they're not actively managing it. They're not trying to outperform the benchmarks or the indexes. They're just buying the broad markets. They're setting a specific allocation for that target date fund, you know, the, the stock to bond ratio, but they're not trying to do anything.
Above and beyond. They're not trying to beat the index. A managed fund is the opposite of that. There's a fund manager who's, who's kind of reading the tea leaves, if you will, and making some, some educated guesses around, um, You know which asset class is gonna perform better than others. And they'll, within these managed target date funds, they'll, they'll actually change the allocations.
They'll, they'll say, Hey, I think international's gonna do better than us. That's just a prediction I'm making and I'm gonna increase the international stock exposure. And that happens within your funds to be clear control.
Nate: Right. Yeah. And to be clear that that's something we don't believe in, um,
Kyle: the manage aspect ex.
Exactly. So if I had my [00:14:00] choice, I'm, I'm gonna choose the passive fund over the managed fund. Mm-hmm. So that actually leads into the next thing I look at, which is expense ratio versus performance. So every mutual fund has an annual expense ratio that, uh, comes out of performance. It's net of performance.
And the fund company gets that, and that's what they get for. Right. You know, keeping track of the mutual fund, you know, all the aspects of it, keeping it in compliance, um, you know, managing all the, the investments in it, um, reporting, all that kind of stuff. And with modern investing, those expense ratios are really low, but on most funds, But some funds have higher expense ratios and oftentimes managed funds have higher expense ratios because the, uh, active manager, uh, is looking to earn an income off of his managed activity.
And if he outperforms the market, he's earned his, his extra expense ratio. And if he hasn't, then you still pay it. So, right. I always look at expense ratio. But expense ratio is not the whole [00:15:00] story. You gotta look at performance too, cuz some funds will have a higher expense ratio than the other fund that you're looking at, you're comparing it to.
But the fund with the higher expense ratio might have a much better performance, in which case you can justify paying the slightly higher expense ratio to get the better performance. So I always look at those two things together. Expense ratio versus performance.
Nate: Okay. Okay. Got it. So, so far we have, we're looking for a passively managed, hopefully low expense ratio compared to the performance.
And that would signify so far a good target
Kyle: date fund. Yeah, that's correct. That's a good summary. Okay, so what else? Yeah, so then I'm looking at global allocation. You know, these target day funds are, they're, they're, they're built, they have these target allocations and not just stocks to bonds, but they have target allocations within those.
What we call sleeves. So within the stock sleeve, it's targeting a specific amount of US stock, a specific amount of international stock, a specific amount of emerging market [00:16:00] stocks, and they're trying to keep it within a. Uh, certain allocation percentages and so mm-hmm. When they make these target date funds, not all of them have the exact same global allocation.
You know, some are gonna have more US stocks, some are gonna have, uh, less US stocks. Some are gonna have, uh, more emerging market stocks. Some are gonna have less emerging market stock. Um, same with the bond sleeve. You know, there, there could be no international bonds at all. I see that all the time. You see just us bonds.
Other ones have international bonds. Um, so depending on. Uh, what level of diversification that you're seeking, depending on, uh, how much US stock you would like to have compared to international stock. Um, all these things kind of factor into the performance of this, of this fund and also, uh, factors into the diversification of the fund.
So it's important to look at global allocation to make sure that it's fully diversified and, um, that it has the appropriate ratios of us to international, uh, exposures. [00:17:00] Okay.
Nate: All right. I, that makes sense to me. Basically, um, you want the diversification to be as high as possible, um, but then there's some logic to like what sleeve you want to be.
You know, essentially where do you wanna be heavy and where do you wanna be lightened as far as US versus international? That which is more complicated. Um, and I think I want to ask you about that after this, but I'll let you, um, I think there's a few more things that you look for. So I'll, I'll come back to that.
So, what else makes a good or bad target date fund?
Kyle: Okay, yeah. Um, the glide path. So we talked a little bit about that. The glide path is the industry term for the rate at which. Uh, you reduce your risk. I e reduce the quantity of stocks you have and increase, uh, your bond exposure, which decreases your risk.
Mm-hmm. Um, not all glide paths are created the same. So some funds, [00:18:00] uh, start really, really, really aggressive and they stay aggressive for a long period of time, and then they start to decrease. Um, mm-hmm. That's on the, that's on the front end. On the back end. Some, uh, same thing. Some funds will stay really risky all the way up till retirement.
Probably more risky than I would feel comfortable recommending to a client, but other funds will be really, really conservative. At retirement, maybe too conservative. And then other funds are gonna be kind of in between. So looking at that glide path risk will give you an idea of how long am I gonna be at high risk and what's my terminal risk?
Like what, how much stocks and bonds do I have once I reach that target year? That target goal of that target date fund. Um, and not all are the same. So you want to find one that fits your strategy and your risk tolerance. I see.
Nate: Okay. So. I I'm gonna go ahead and, and ask the question now because I think it'd be helpful for the listeners.
So you're talking about you, you're kind of saying there needs to be an [00:19:00] appropriate level of risk at each stage of the game and you there needs to be an appropriate diversification, which is hopefully very high. Yeah. And, um, there needs to be, the, the allocation into each sector sort of needs to be quote unquote right it, right.
How do you find out what's right, like what's appropriate and, and what allocations in or, or what sectors to be in and how much to be in each sector. Like where do you go for some knowledge about that?
Kyle: Yeah, so the most readily available information, first of all, you wanna find the information first. Like what is the glide path?
What is the global allocation? You know, what are these things, right? What's the expense ratio? Is it passive or managed? The easiest place the. Uh, is right there in your 401k. There's usually a link. Usually you can click the fund name or there's a little link next to it. You click and it gives you this fly out pdf of, of the fund and it, and it tells you [00:20:00] all about the fund.
Um, sometimes those handouts are great because they're, uh, a handout from a third party. Security review website, it's from a third party, and so you can kind of feel comfortable with that data, but oftentimes what you see is when you click on the little handout on the 401k, it's a, it's a data sheet from the fund company and of course they want you to invest in their fund, so they're gonna put, they're gonna make it kind of really appealing right to you.
Mm-hmm. Almost like a sales tool, I would say. And so really the best way to look into it is to find a third party website. That all it does is it gets the data feeds from all the investments and they give it to you unfiltered. Mm-hmm. And you can, you get the, the, the, just the raw data basically. And so that's where I go to find that data now, to find out what is gonna fit for you.
You know, first of all, you have to identify your strategy and you have to identify what you're comfortable with. You know [00:21:00] what, so for example, I'll meet with a physician. And, uh, we'll be talking about a, a target date fund and their 401k, and I'll be like, we'll be looking at it together, uh, on a website, you know, we'll both look at the same website and they'll ask me, they'll say, Hey, I see that.
Uh, I'm 90% stock, so that's what I'm shooting for. And I see this fund as 60% US stocks and 30% international stocks. I don't feel comfortable investing in that much international stock. And I go, well, well, why is that? And then we talk about it and, you know, it, it, it, the end of the conversation could be that they are not comfortable putting 30% of the money in the international markets.
Mm-hmm. Even though I would recommend that, and I feel comfortable with that, that might not be what's right for them. And so that's just an example of, I can't. Tell you where to look for that. It's just something that you, it's a decision you have to make. Okay. Yeah. As part of your, part of your overall strategy.
Nate: Okay. That makes sense. And, and I think, you know, there are some, you know, big name investment [00:22:00] companies, whether it's Fidelity, Vanguard, or Black BlackRock or whatever it is that have sort of some, you could look at their funds and see kind of what they think, uh, but it sounds like it's not. Obviously no one's got it exactly right.
We're working with a round number here, thir 30 and 60% usually. But, um, you could check that out and see, see what the LE leaders in the industry think and kind of pin that against your own fund. And you use a third party in a website to do that. Sounds like that's what, how you might, might, uh, compare. So, um, let's talk about.
So you just basically said if you have, let's imagine worst case scenario, you have a target date fund that is actively managed in your 401k. The performance isn't very great, right? Maybe there isn't enough diversification or the glide path risk is [00:23:00] taking too much risk or not enough risk to, you know, achieve your goals.
Something along those lines where you're thinking, this is, I found a bad target date fund, uh, in my 401k, four three B. What do you do? Like if you, this is your strategy, you, you've decided I'm a target date investor, which is a pretty great strategy for most physicians. Uh, what do you do after you've just figured out that your target date fund at work is just not up to par?
Kyle: That's a great question. Um, yeah, so. This happens. I, I look at physician retirement plans. Uh, we're a target date strategy. We've got that established. Uh, we're, we go into the plan, we look at the fund lineup, there's a target date fund. Immediately we're thinking, all right, we're good to go put everything in that, but we gotta do our due diligence.
We gotta look at it. And we look at it and we're like, yeah, this is, there's something wrong with this. And we talk about it and it's wrong. So yeah, what do we do? Like how do we, how do we implement this strategy now without the target date fund? Um, [00:24:00] If you recall earlier, we, we alluded to those individual index funds that are mm-hmm.
Always, oh, right. Sitting there right next to the target date fund in your fund lineup. So you start looking at those next, you know, and most of the time you're gonna find just garden variety index funds majority of the time. Um, and so those are gonna be the next best alternative. But you kind of run into that problem now where I.
Like you said, like, well, how much, how much US stock and international stock do I buy? And my allocation is changing over time. I'm getting less stocks and more bonds over time. How do I keep track of that with these individual index funds? Because now you're buying three to five individual funds. You're setting certain percentages that you're buying at, but it's gonna be a fixed percentage, and those asset classes are going, some are gonna increase in value, some are gonna go down.
Mm-hmm. And you're gonna get out of target. So how do you rebalance with index funds? Using a target, uh, target date strategy as your overarching strategy. So this is what I recommend. Uh, Go out and find your [00:25:00] favorite target date fund. Just, you know, do the research. Ask around, you know, find the one that you're comfortable with.
Look at it. Get on this third party website like a Morningstar or Yahoo Finance, something that's not the fund company's website. And look up that, fund that target date fund and look it through. You know, look at, is it passive managed? What's the expense ratio, what's performance, the allocation, the glide path?
And you're like, yeah, this is the one I love, this this target date fund. If I could buy this in my 401k, this is the one I would buy, but it's not available so I can't buy it. So what you do is you use that fund, your favorite target day fund as a proxy. You just basically mirror it. You. You take those index funds and you go, well, how much US stock does my favorite target date fund have?
Oh, it's got 60%. Okay, I'm gonna buy 60% of the US stock Index in my 401k. Okay, how much international stock, how much bonds? And you just go ahead and just mirror that. Okay? And that's [00:26:00] how you get that set up.
Nate: Great. All right. So that seems, I mean, that's some work, but it's, it's reasonable. You essentially find, you, you assuming you have, like you said, garden variety index fund, um, available to you and you use all the ones that you probably possibly can, right?
It's, uh, US international, but you're looking at a different glide path fund that you like. So you just try to do your best you can to man to, to mirror it. So, um, I'm gonna, I'm gonna put a bow on top of this. Okay. So, sounds like you can correct me if I'm wrong. If your target date fund isn't passively managed, isn't globally diversified or has high expense ratios, then you should consider, uh, building out your own portfolio u using that sort of proxy fund strategy.
Is that right? That's correct. Okay, great. Anything else you can think of that our listeners would want to know about target date funds? [00:27:00] Yeah,
Kyle: I'd just like to end with giving the listeners a little warning or caveat to, uh, using the proxy fund and the index funds in their 401k to build a target date strategy, uh, within the account.
And that's that you can't take your. Your finger off the pulse, if you will, on that strategy. You, you have to make sure that you come back at least every once, once a year or every two years to do a rebalance because you are on that glide path and your allocation will be changing with time. And so when you go to rebalance, you need to take that into account.
So just make sure that when you sit down to rebalance, you use that proxy fund and you adjust. The allocation in your 401k, um, to match that glide path cuz what you want to prevent is having the account drift off into the weeds, end up with too much stock before retirement. Suffer a major stock market loss right when you need your money the most and not have the retirement that you hope for.
So it's very important to [00:28:00] use that proxy fund and rebalance. Reducing your risk over time. Great. Thank you
Nate: Kyle. That's all for today. Until next time, remember, you're not just making a living. You're making a life.
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