top of page

roll your own target date fund, part 1: introductions

If there’s any place where the investment world falls into the “one-size-fits-all” trap, it’s in target date funds. Don’t get me wrong — they’re a good place to start — but the chances of any given target date fund being just right for you for your entire life are slim to none. Case in point: the uproar in 2009, when funds targeted for people retiring that year took a beating, dropping up to 41% in value! But here’s the kicker — I’m not saying that the funds were poorly designed. I’m saying that they weren’t right for the people who were yelling about them, who didn’t fully understand what they were getting into. I would love it if there were an investment out there that magically tailored itself properly to the person who bought it; until that day, I highly recommend you roll your own “target date fund”. Don’t worry — it’s not nearly as complex as it sounds!

A quick primer on target date funds

A little review: target-date funds are mutual funds that are designed to achieve a certain goal, generally either retirement or college matriculation in a certain year. They do this by gradually changing their asset allocation from very aggressive (risky but long-term rewarding stuff, like international stocks) at the beginning to conservative (stable but less long-term rewarding stuff, like short-term bonds) as the target date approaches. The idea is that you get the benefit of higher expected returns when you can afford to take the risk — and stability when you can’t.

This gradual shifting of allocations is called a “glide path”, and every fund company uses a different one. For some examples, check out this wiki page from our good friends the Bogleheads. It all looks very scientific, but truthfully, there’s a lot of guesswork involved — especially since the fund has no idea what you need. What if you plan on delaying social security claims, and thus having completely different income needs your first few years of retirement? What if you’re keen on leaving a legacy, and have more than enough money to handle market fluctuations? What if (as happened to a lot of folks in 2009) a drop of more than 10% in your retirement funds would cause you to panic, sell everything, and put it in cash, where it would subsequently get mauled by inflation? Each of those situations calls for a radically different allocation, but the target date retirement fund doesn’t know that, and if you don’t know that it doesn’t know, you may end up blindsided.

Building the glider: the basics

So, if a target-date fund could leave you high and dry, how do you go about building a replacement yourself? First off, don’t worry about creating a “glide path” that makes assumptions about what things are going to be like 20 years from now — the only thing you know for sure is that they’re going to be different. Glide paths are for institutions that don’t know your personal situation! Rather, you’re going to focus on the allocation that makes sense now, and you’re going to revisit this once a year. Once you’ve gone through the exercise once, it’s a breeze to revisit — just make sure you’ve got a calendar entry or reminder set up, or you may find yourself losing half your portfolio the year before you’re set to retire!

Really, it’s just a three-step process:

1) Determine your asset allocation: what percentage of your portfolio are you going to allocate to stocks v. bonds? International v. domestic? Small-cap v. large-cap? A lot of research has been done on this, but until (or unless) you dive in deep, there are some basic rules that will get you 90% of the way there.

2) Determine your asset location: how much of your portfolio is in a tax-advantaged account? Roth v. Traditional? Again, some basic rules will help you out.

3) Determine the funds you will use to implement your allocation. If all of your retirement is in a 401(k), this choice is often more or less made for you. If you have an IRA, then you’ve got a double-edged sword: you generally have access to better (cheaper/more transparent) funds, but the choices can be overwhelming.

And yes, once you’ve been at the investing game for a while, you’re liable to collect quite a handful of accounts — 401(k), Traditional IRA, Roth IRA, brokerage account, etc. etc…and one of each of those for your spouse, as well! This is where a rudimentary knowledge of spreadsheets — or a friendly expert who can set it up for you — comes in handy!

That’s it! Don’t worry, I won’t leave you hanging; the next few posts will go into detail on steps one and two. Stay tuned!

bottom of page