Women’s Retirement Planning: Avoid Guy-Speak, Go for TDFs
A target date fund is an easy and elegant way to get started
More than three quarters of certified financial planners (CFPs) are men. And, though enlightened exceptions exist, too many of the guys tend to speak in a language of short-term performance and of beating the market, making it all sound like a competitive sport. Some of the men also tend to glory in the complexity of investing, rather than look for what’s simple.
Women clients, meanwhile, would like to hear about meeting their long-term goals.
The number of women CFPs hit 20,000 last year, a record, though still far too few. If you’re one of the 35% of women who, in a Fidelity survey, said you don’t invest because you don’t know where to get started, here’s some advice: Avoid the guy-speak and instead employ one of the simplest and lowest-cost financial products around, the target date fund (TDF).
A TDF can be a one-and-done choice. After you set up your investment (it can be a lump sum, or periodic investments), you can sit back and let the TDF handle all the important decisions.
A short course in all things TDF:
Every TDF has a year in its name. Someone in their 40s today who expects to retire in 25-ish years, might choose a TDF with 2045 in its name. In your 20s? No worries, there are 2060 TDFs for you.
A TDF will own a mix of stocks/bonds/cash based on how long until you expect to retire. Over the years, as you move closer to your target retirement date, the fund will get incrementally more conservative, shifting some money out of stocks and into bonds.
How much is invested in each type of asset is based on modern portfolio theory (MPT), which focuses on both potential reward (returns) and the risk needed to achieve those returns. This risk/reward approach won the creator of MPT a Nobel Prize in Economics.
The TDF will automatically check the portfolio from time to time to make sure it’s still hewing to its target mix of stocks/bonds/cash. When a given investment has grown too big (or too small), the TDF will “rebalance” to get back to the target allocation. For instance, let’s say a TDF aims to have 80% in stocks and 20% in bonds. If there’s a big stock gain and the mix shifts to 85% stocks and 15% bonds, the TDF will move some money out of the stock portion and reinvest it in the bond portion. This is a crucial step that many DIY investors typically fail to pay attention to, which can impact their risk/return outcome.
The major fund/brokerage firms such as Fidelity, Schwab and Vanguard all offer TDFs that use index funds. Study after study after study have shown that very few actively managed funds manage to outperform index funds. And even fewer that manage that feat over a short period (say, a year or two) manage to keep it up.
And the index TDFs at these firms charge very low fees to invest. Every mutual fund charges an annual fee, called the expense ratio. You won’t ever see a line-item deduction on your statement for the annual expense ratio. It is a fee that is sliced off of a fund’s gross performance before your account is credited. Actively managed funds typically have higher expense ratios than index funds; that higher cost reduces the net performance investors actually earn.
Fidelity and Schwab let you get started with whatever you can manage. Vanguard requires an initial investment of at least $1,000 in a TDF; after that you can make additional investments as small as $1. And at each company it’s easy to set up an automated investing schedule. Once you link a bank checking or savings account to your fund account, you can schedule periodic transfers into your TDF, such as weekly, monthly or quarterly.
If you anticipate your annual contributions will be no more than $6,000 (or $7,000 if you are at least 50 years old), you might want to consider owning your TDF inside of a Roth IRA account. (In 2021, individuals with modified adjusted gross income below $125,000 and married couples filing a joint return with income below $198,000 can contribute up to those maximums.) Money you withdraw from a Roth IRA in retirement will be 100% tax free.
A TDF can be a terrific long-term solution. Might you do better building a more personalized portfolio at some point? Maybe. Maybe not. The automated hands-off structure of TDFs can be a sneaky-smart way to avoid behavioral biases that can hurt performance, especially during times of market stress.
And right now, if you’re struggling with getting started, a TDF can be the mechanism that pushes you off the fence. How long you stay in the TDF is something to consider later on. Don’t let pursuit of the perfect be the enemy of the good. A TDF is a very good place to start.