Question on Retirement Plans & Target Date Funds

[Benjamin Sulka]

Retirement plan question here: 

This question is not real estate related. It's related to retirement plans through your employer (if you're working full time). I just graduated college in May and started working full time in July. My current plan is a 403(b) plan. 

I did some exploration to see what my employer retirement plan is invested in. It's invested solely into target date funds which I've heard pros and cons about. 

The other options that I have to choose from a pretty limited and most are target date funds. However, there are some options to invest in the S&P 500 through index funds like VIIIX (Vanguard Institutional Index Fund) with a focus on tech companies like Apple, Microsoft, Google, Nvidia, Tesla, Amazon, etc. Investing in companies like this is more of my inclination but I'm really not sure what to do here. 

Trying to see if anyone has knowledge about target date funds and whether it would make more sense to simply invest in the S&P 500. 

I also plan on opening a Roth IRA and investigating that further.

Thanks so much for any insight! 

-Ben, aspiring rental property owner and financial freedom seeker

[Byron Valles]

Hey Benjamin, 

The difference between the target date fund and the other index funds like VIIX is all about Asset Allocation or where the dollars are invested. 

Starting with the VIIX,  the objective of the fund is to track the performance of the Standard & Poor’s 500 Index, which measures the investment return of large-capitalization stocks. In simpler terms, the fund's dollars will be invested in large domestic companies like the ones you mentioned (Google, Amazon, etc. ) It's worth noting that by definition this fund does not include smaller or international companies or any type of bonds. 

The objective of target date funds on the other hand is to periodically trim the asset allocation towards a more conservative stance. Here's a basic example of how that might look like:

a 2040 target date fund today may look like this:

50%: Total domestic companies including large, mid, and small

30% International companies

16% Domestic bonds 

4% International bonds 

Then, as time goes on the fund manager will periodically trim from the more historically risky asset classes like domestic and international stocks and into more historically conservative asset classes like bonds. The idea behind the trim is that for most people it's prudent to invest in more income-generating assets like bonds (vs capital growth type of assets like stocks) as they get closer to retirement. Therefore that same fund in 10 years could look like this:

45%: Total domestic companies including large, mid, and small

15% International companies

30% Domestic bonds

10% International bonds

Target date funds are often used by the "set and forget" type of folks. 

I hope this helps! 

Byron