If you’re confused by which target date fund to choose, you might be tempted to have multiple target date funds to afford you the most flexibility in retirement.
Is that a good idea or a bad idea? Money expert Clark Howard recently answered that question during a live Facebook event.
If you listen around the 8:25 minute mark of Clark’s May 2019 Facebook Ask Me Anything chat, you’ll hear the following question:
In an IRA or 401(k), you talk about doing target date funds. Would there be a benefit to have different years for after-retirement target date funds — kind of like laddering CDs? So you might have 2040, 2050 and 2060 funds in your portfolio?
A word about target date funds
OK, let’s take a step back before addressing the question…
In case you’re not familiar with target date funds, the personal finance expert calls them the “best and easiest investment choice you could ever make” because of how simply they operate.
With a target date fund, you just pick the year that’s closest to your expected date of retirement and make your contributions.
“The beauty of a target date fund is the professionals providing those funds to your 401(k) or IRA plan do a mix of investments that they believe, based on their modeling, is appropriate for the point you are in relation to retirement,” Clark says.
The fund manager will automatically adjust the mix of stocks and bonds in the fund so you have less risk as you near retirement. You don’t have to worry about re-balancing; it’s all done for you. No mess, no fuss!
Understanding laddering as background
Next, before we can get Clark’s answer to the question above, we have to address the part about CDs to give you the lay of the land.
The idea of laddering CDs is that you take your money and split it into five even piles. Then you buy a 1-year CD, 2-year CD, 3-year CD, 4-year CD and 5-year CD.
Every 12 months, when a CD comes due, you turn around and re-up that money into a 5-year CD. By doing this, you always have access to 20% of your money being rolled over at what hopefully will be higher interest rates in the future.
So the Facebook AMA question Clark received is could you use this same strategy when deciding which target date fund to choose? In other words, should you have multiple target date funds?
“As far as mixing and matching the year, I don’t support that idea,” Clark begins.
“I think you pick the year closest to when you expect to retire and that is the target date you go into. Because even in retirement, that target date fund continues after that year and as you age steadily becomes more conservative.”
However, there is an alternative strategy that Clark says he’s “neutral” on. And that is, if you are a really nervous investor, you could go one decade earlier on your target date fund.
“So let’s say you’re retiring in 2050, but you’re really nervous about being too aggressive in your investments. You could consider going into a 2040 or 2045 as if you were retiring five or 10 years earlier than you actually are,” Clark notes.
“That would give you a more conservative mix of your investments. You’ll likely have a little lower return on the money you’re building for retirement, but that is an alternative.”
So, if you’re confused about which target date fund to choose, know that Clark is not a fan of laddering or splitting your money among multiple target date funds.
Just estimate the year closest to when you expect to retire and put all your money into that target date fund. This is one financial product that’s supposed to be simple, so don’t try to overthink it!
Meanwhile, if you’re just getting started out investing, you may want to check out our guide to target date funds.
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