Tag: index funds

  • Why Target Date Funds: The Easy Way to Invest

    Why Target Date Funds: The Easy Way to Invest

    Don’t be fooled. The easiest option can also be the best option.

    You already know I’m a big fan of making things easy, especially investing.

    And, there is no better example of making things easy than investing in target date funds.

    Maybe we’ve been brainwashed into thinking that the harder something is, the better it is. Of course, there’s that often-repeated phrase, “If it were easy, everybody would do it.”

    We’ve been programmed into thinking that “hard work” automatically means “better results.”

    I certainly agree that hard work pays off when it comes to things like career and exercise.

    As another example, baking cinnamon rolls comes to mind. With cinnamon rolls, the harder way is probably also the better way.

    My daughter and I bake pre-made cinnamon rolls every week. We have fun with it and it’s quick and easy.

    She loves how they taste, so that’s all that really matters. But, they don’t come close to tasting as good as homemade cinnamon rolls, which are certainly harder to make.

    So in the context of cinnamon rolls, I think “harder” does mean “better.”

    On the other hand, I don’t agree that investing has to be hard. I don’t believe that just because something is easy, it must not be that good.

    And, that brings us to target date funds.

    There’s nothing easier than investing in target date funds.

    My wife and I have been investing in target date funds for years. Target date funds have been both easy and effective for us.

    That’s important because we’re also at the stage in our lives where we are trying to make things easier, not harder.

    The idea behind target date funds is that your portfolio automatically rebalances as you move closer to your predetermined life event, like retirement or your kid’s college start date.

    That means over time, your target date fund will gradually become more conservative to protect all the money you had saved and earned over the years. It typically does so by reducing exposure to stocks and increasing exposure to safer assets, like bonds.

    You do not have to do a thing. 

    It simply cannot get any easier than this.

    Today, we’ll take a closer look at how target date funds work. The goal is to help you make an informed decision on whether they are the best option for your situation.

    Before we jump in, if you need a refresher on some key investment terminology, check out my post on the language of investing:

    Learn the Language to Make Investing Easier

    What are target date funds?

    Target date funds are a form of mutual fund. When you invest in target date funds, you are essentially getting a complete portfolio in a single fund.

    Target date funds are typically comprised of broad stock index funds and bond index funds.

    That is one of the keys to remember about target date funds. They automatically provide investors with strong diversification and optimal asset allocation based on their chosen time horizon.

    Target date funds are ideal for long-term investment goals. They are designed to help you manage risk as you move closer to your pre-determined goal.

    Typically, target date funds invest more heavily in stocks in the early years in an effort to earn greater returns. As you move closer to your pre-determined goal, the fund will automatically shift to buying safer assets, like bonds.

    What types of investments are typically in target date funds?

    Most target date funds are made up of index funds. That means that when you buy a target date fund, you are getting exposure to a wide variety of stocks and bonds through index funds.

    An index fund is a type of mutual fund that seeks to track the returns of a market index, like the S&P 500 Index.

    As explained by Vanguard:

    An index mutual fund or ETF (exchange-traded fund) tracks the performance of a specific market benchmark—or “index,” like the popular S&P 500 Index—as closely as possible. That’s why you may hear people refer to indexing as a “passive” investment strategy.

    Instead of hand-selecting which stocks or bonds the fund will hold, the fund’s manager buys all (or a representative sample) of the stocks or bonds in the index it tracks.

    It’s very hard, even for professionals, to beat the returns of the S&P 500. Historically, the S&P 500 has averaged an annual return of 10%.

    Hit your Target by investing in target date funds, whether that target is saving for retirement or something else, like your child's college.
    Photo by Artur Matosyan on Unsplash

    I Invest in target date funds because they give me a great chance to match those historical average returns without any effort on my part.

    What are the advantages of investing in target date funds?

    Target date funds share the same benefits as investing in index funds. That’s because, as we just discussed, most target date funds are comprised of index funds.

    In addition to the benefits of index funds, target date funds offer one additional major benefit we’ll discuss below.

    By the way, you already know 7 things I love about index funds:

    1. Anybody can do it
    2. No wasted mental energy
    3. Low fees
    4. Automatic diversification
    5. The closest thing to predictability
    6. I don’t have stock FOMO
    7. Good enough for Buffett, good enough for me

    For a more in depth look, check out my post here:

    7 Things I Love About Index Funds

    Target date funds automatically rebalance

    In addition to sharing the 7 benefits of index funds, target date funds offer one additional, major benefit:

    automatic rebalancing

    Importantly, target date funds automatically rebalance to continuously maintain your optimal mix of stocks and bonds.

    That means as time goes on, you don’t have to worry about rebalancing on your own. That’s one less stressor on your plate.

    What do I mean by rebalancing?

    Let’s say an investor’s optimal asset allocation is 50% stocks and 50% bonds. After a year of impressive stock market growth, this investor’s portfolio now consists of 60% stocks and 40% bonds. That’s because his stocks increased in value at a greater rate than his bonds.

    As a result, he’s now weighted more heavily in stocks than his optimal asset allocation. To rebalance his portfolio, he could take a variety of steps. He could sell some stocks or purchase more bonds to get back to where he wants to be.

    With target date funds, he would not have to worry about this situation. That’s because target date funds automatically rebalance for you.

    That’s a big load off an investor’s plate. It’s the main reason why I like investing in target date funds.

    Target date fund or build your own?

    After you open an investment account, you can select a combination of index funds on your own or choose a target date fund.

    There’s nothing wrong with buying index funds on your own instead of through a target date fund.

    You will actually save money on fees if you go that route, but not very much.

    For example, the popular Vanguard Total Stock Market Index Fund (VTSAX) charges a fee of .04%.

    Vanguard’s Target Retirement 2065 Fund presently charges a fee of .08%.

    Just remember to rebalance your portfolio from time-to-time to stay within your preferred asset allocation.

    If you don’t want that added responsibility, you can invest in a target date fund that automatically chooses the index funds for you.

    Then, the target date fund will automatically rebalance your portfolio over time to maintain an optimal balance of stocks and bonds.

    As you saw above, you will pay slightly more in fees for the added convenience. To me, that extra .04% in fees is absolutely worth it.

    In the end, both options are good ones.

    Investing with target date funds is the easiest choice.

    How can you invest in a target date fund?

    Most employer-sponsored retirement plans, like 401(k) plans, now offer target date funds. In fact, target date funds are usually the default investment option for new plan participants.

    You can also invest in a target date fund outside of your employer-sponsored plan. Most major investment companies offer target date funds in a variety of account types.

    In addition to retirement accounts and traditional brokerage accounts, 529 college savings plan providers usually offer target date funds based on when your child will start college.

    If you’re curious about my favorite investment account types, you can read more here:

    My 4 Favorite Investment Accounts

    Regardless of the account type, the process for selecting the right target date fund is the same.

    Generally, you’ll see various target date fund options based on your personal time horizon.

    For example, if you are currently 25-years-old and plan to retire in 40 years, you would select the target date fund corresponding to 2065. This fund will automatically rebalance as your career progresses towards that retirement date.

    Typically, there are target date funds offered in 5-year intervals. Choose the one closest to your preferred retirement year, even if there isn’t one that matches your exact year.

    The same concept applies to a 529 college savings plan. If you have a newborn, like I do, you would select the plan that corresponds with your child starting college around 2043.

    After you make this one decision, there’s nothing more to do it.

    Your focus should be on adding as much money to that account as possible without worrying about things like rebalancing.

    I personally invest in target date funds.

    My wife and I invest in multiple target date funds. We have various target date funds for our retirement savings and for our kids’ college education.

    At this stage in our lives, we’ve placed a premium on doing things the easy way.

    We have full-time jobs as attorneys, manage our own rental properties, and have three kids at home. The last thing we need is to add more complication to our lives.

    Our personal accounts are with Vanguard, which has long been known as an investor-friendly company that prioritizes low fees.

    Why target date funds?

    Just because something is easy doesn’t make it wrong.

    Investing in target date funds is as easy as it gets. By taking the easy option, you can have exposure to a broad range of index funds that automatically rebalances over time.

    Are you doing things the easy way?

    If you’re a busy professional like I am, don’t sleep on target date funds.

    You’ll always have people that look down upon target date funds as too basic. Ignore them. Let them stress about picking the next hot stock, rebalancing, and timing the market.

    • So, are you doing things the easy way? Are you a target date fund investor?
    • Do you agree that target date funds are an easy and effective way to invest for the long term?
    • Has anyone ever looked down on you for investing in target date funds?

    Let us know in the comments below.

  • 7 Things I Love About Index Funds

    7 Things I Love About Index Funds

    For my money, there’s no beating index funds.

    More important, than my money, for my sanity, there’s no beating index funds.

    In today’s post, I want to highlight 7 things I love about index funds.

    My 7 reasons range from the low costs and automatic diversification to the minimal mental effort required for long-term wealth.

    If you’ve been a consistent reader of the blog, you know that money is as much emotional as it is rational. I don’t want to be worried about my money any more than you do.

    That’s why the reasons I love index funds take into account both the numbers and the emotions of investing.

    Let’s dive in.

    7 Things I Love About Index Funds

    1. Anybody can do it
    2. No wasted mental energy
    3. Low fees
    4. Automatic diversification
    5. The closest thing to predictability
    6. I don’t have stock FOMO
    7. Good enough for Buffett, good enough for me

    1. Anybody can do it

    I’ve said it before, and I’ll say it again:

    Investing is actually the easy part.

    And, when I say investing is actually the easy part, I’m talking mostly about investing in index funds.

    You don’t need an MBA or a financial background. You don’t need to read the Wall Street Journal.

    All you need to do is consistently fuel your investment account and to let compound interest work its magic.

    Oh wait, one more thing:

    You also need to read Think and Talk Money. I post three times every week.

    Oh, and tell your friends about Think and Talk Money!

    2. No wasted mental energy

    It goes without saying that most professionals are busy people. On top of working our day jobs, we’re also doing our best to stay healthy, be good family members, and have some semblance of a social life.

    Some of us even have side hustles that occupy our time and mental energy.

    Hot stone bath in the mountains because this man read Think and Talk Money and invests in index funds.
    Photo by Robson Hatsukami Morgan on Unsplash

    The last thing we need is another stressor in our lives, like actively trading stocks.

    I invest in index funds to take this stressor out of my life.

    Yes, I could pay someone a lot of money to manage my money for me.

    Or, I could invest in index funds and rest comfortably knowing that I’m going to be in great financial shape down the road.

    Why am I confident I’m going to be in great financial shape?

    For three main reasons, discussed next.

    3. Low fees

    Because index fund are passively managed, the fees are significantly lower than actively managed mutual funds.

    My favorite index fund is Vanguard’s popular fund called the Vanguard Total Stock Market Index Fund (VTSAX). This fund currently charges .04%, which is just about the lowest fee you will ever see.

    Compare that to the 1% fee commonly charged by investment advisors. Also, don’t forget it’s very difficult for even the professionals to beat the returns consistently generated by the S&P 500.

    If you don’t think that difference in fees matters, check out my post on what a 1% fee really costs you:

    What a 1% Fee Really Costs You

    While I can’t control what returns I may earn, I can control the fees I pay.

    I’d rather pay .04% than 1%.

    That’s especially true when there’s no guarantee that an advisor can perform better than the returns I earn through index funds.

    4. Automatic diversification

    By investing in an index fund, like an S&P 500 index fund or a total stock market index fund, my stock portfolio is by definition diversified.

    For example, when I invest in an S&P 500 index fund, I essentially own a piece of 500 large companies.

    Some companies may go up in value, others may go down. I’ll never know which ones are going to make money or lose money. By investing in an S&P 500 index fund, it doesn’t matter. I’m covered either way.

    That’s the point of diversification: smooth out the ride so I’m less susceptible to the fortunes of one particular company.

    Man with fresh organic coconut relaxing because he invests in index funds as learned on Think and Talk Money.
    Photo by Artem Beliaikin on Unsplash

    As another example, I also invest in Vanguard’s total stock market index fund (VTSAX). This fund offers exposure to nearly the entire U.S. stock market, which consists of 3,598 companies.

    Now, that’s really good diversification.

    5. The closest thing to predictability

    The S&P 500 has historically earned an average annual return of 10%.

    By investing in an index fund that tracks the S&P 500, like I do in my 401(k), I have a pretty good chance of earning consistent returns in the long run.

    Sure, there may be ups and downs.

    But, check this out:

    Since 1996, the S&P 500 has ended the year in positive territory 23 times and negative territory only 7 times.

    In other words, the S&P 500 has generated positive returns three times more frequently than it generates negative returns.

    And even with those 7 negative years, with the exception of 2000-2002, the S&P 500 returned to positive territory the following year.

    What this all means is that while the S&P 500 will drop occasionally, the down periods are historically short-lived.

    Because of this historical consistency, index funds give me the best shot at predictability.

    Note that predictable returns does not mean guaranteed returns. There are no guarantees in the stock market. That’s why my preference is predictability.

    I’m very happy with consistent returns and a smoother ride.

    6. I don’t have stock FOMO

    Depending on the index fund you choose, you may own pieces of a handful of companies or as many as 3,598 companies.

    I invest in S&P 500 index funds and total stock market funds. That means I own pieces of lots of companies.

    It also means I never have stock FOMO.

    You know what stock FOMO is, right?

    Stock FOMO is when you find yourself in a conversation talking about something fun like your favorite new show. Then out of nowhere, someone volunteers the hot stock he bought that’s up 20%.

    If you have stock FOMO, you feel like you’re missing out by not owning that stock. You think to yourself, “Oh man, that guy’s going to be so rich and I missed the boat!”

    You might even run back to your desk so you can buy that hot stock, not realizing that you’ve probably already missed the train.

    Stock FOMO can cause a lot of stress. I don’t want that stress.

    So, I invest in index funds.

    When a stock jumps 20%, I feel good because I already own every company in the U.S. stock market.

    No stock FOMO here.

    7. Good enough for Buffett, good enough for me

    In 2013, Buffett famously instructed that after he dies, his wife’s cash should be split 10% in short-term government bonds and “90% in a very low-cost S&P 500 index fund.”

    Good enough for Buffett, good enough for me.

    It’s not just Buffett, though. One of my favorite authors on investing, J.L. Collins, wrote about the advantages of investing in a total stock market index fund in his seminal book, The Simple Path to Wealth. 

    In fact, Collins makes a compelling argument that the Vanguard Total Stock Market Index Fund (VTSAX) we discussed above may be the only stock fund that you’ll ever need.

    Buffett and Collins are smart guys. Taking advice from smart guys seems like a good idea to me.

    I highly encourage you read The Simple Path to Wealth.

    What do you think of the 7 things I love about index funds?

    To recap, I love index funds for these 7 reasons:

    1. Anybody can do it
    2. No wasted mental energy
    3. Low fees
    4. Automatic diversification
    5. The closest thing to predictability
    6. I don’t have stock FOMO
    7. Good enough for Buffett, good enough for me

    My reasoning combines the emotional side and the rational side of investing.

    Like you, I want to earn a nice investment return. At the same time, I don’t want to be worried about my investments 24-7.

    Index funds give me the best of both worlds.

    What am I missing?

    Help me grow my list of 7 into a list of 10 by leaving a comment below on why you invest in index funds.

  • Money Questions: Markets in Free Fall

    Money Questions: Markets in Free Fall

    A reader reached out late last week and asked, “What do you do when the markets are in free fall?”

    It’s a question that really captures the intersection between money and emotions.

    I’m not an investment advisor, but I’m happy to share what I’m currently doing as the markets drop. Your personal situation may be different than mine so be sure to check with your investment advisor.

    Before we jump in, here’s a recap from Yahoo! Finance about how significant the drop was last week:

    US stocks cratered on Friday with the Dow Jones Industrial Average (^DJI) plunging more than 2,200 points after China stoked trade-war fears and Fed Chair Jerome Powell warned of higher inflation and slower growth stemming from tariffs.

    The Dow pulled back 5.5% to enter into correction territory. Meanwhile, the S&P 500 (^GSPC) sank nearly 6%, as the broad-based benchmark capped its worst week since 2020. The tech-heavy Nasdaq Composite (^IXIC) dropped 5.8% to close in bear market territory.

    The major averages added to Thursday’s $2.5 trillion wipeout after China said it will impose additional tariffs of 34% on all US products from April 10 — matching the extra 34% duties imposed by Trump on Wednesday.

    My hyper-technical analysis: that’s not good.

    Read on to see how I’m handling the market drop, how The Simple Path to Wealth helped shape my personal investing strategy, and how Die with Zero changed my perspective on how much to save for retirement.

    Let’s dive in.

    So, what am I doing with my portfolio right now while markets are falling?

    Despite how bad it seems, this is not a difficult question for me to answer.

    I’m not doing anything.

    I invest in the stock market to help achieve my long-term goals. My two main long-term goals are to save for college and to save for retirement.

    Each objective is so far away that time is on my side.

    man puts fingers down in lake kayaking against backdrop of golden sunset, unity harmony nature illustrating staying calm when markets are in free fall.

    My oldest child is five-years-old. I have 13-14 years until she even begins college. We make regular contributions to a 529 college savings plan to pay for her education. We fully anticipate that the market is going to go up and down over these next 13-14 years.

    As for retirement, I’ve still got decades in front of me. Same as what we just talked about with saving for college, I fully expect the market is going to go up and down many times before I retire.

    Make no mistake, I don’t enjoy seeing my portfolio drop so suddenly.

    Like everyone else, I don’t enjoy seeing my portfolio drop suddenly.

    It’s not fun to read the headlines right now. My brain seems to jump to the worst case scenario. Maybe you do the same thing. It’s nice to have someone to talk to about it. Misery loves company, right?

    This is one of the reasons why I only look at my portfolio once per month when I track my net worth.

    To remind myself to hold steady during the down times, I think of a study that examined what would happen if an investor missed the 10 best days for the market in each decade since 1930.

    As summed up by CNBC:

    Looking at data going back to 1930, the firm found that if an investor missed the S&P 500′s 10 best days each decade, the total return would stand at 28%. If, on the other hand, the investor held steady through the ups and downs, the return would have been 17,715%.

    These results illustrate how risky it would be for me to try to time the market. The last thing I want to do is miss the upswing. I have no idea when it’s coming.

    But, time is on my side.

    I’m going to do my best to be in the market when that upswing eventually comes.

    And, I am confident that upswing will come. It may not be until years from now. That works for me and my investment horizon.

    One other mental hack that’s helping me right now:

    I’m telling myself that the market is on sale right now. How so? I can buy the exact same stocks today for less money than they would have cost even a few days ago. I do love a good sale.

    In the end, no matter how bad things seem right now, I plan to continue making regular contributions to each of my investment accounts.

    Since I’m investing for the long run, I’ll let the market do its thing while I’m off doing my own things.

    Disclaimer: Your situation may be different. I am not an investment advisor. Do your homework and make the best decisions for your personal situation.

    What is my personal investing strategy?

    My personal investing strategy is largely based off of J.L. Collins’ exceptional book The Simple Path to Wealth. If you want a complete and easy to understand guide on all things investing, check out The Simple Path to Wealth.

    If nothing else, it’s crucial to educate yourself so you can make informed decisions, especially in times of economic uncertainty like we’re in right now.

    The Simple Path to Wealth is a great place to start when it comes to investing in the markets.

    As Collins explains, benign neglect of your finances is never the solution. ReadThe Simple Path to Wealth and check out Collins’ website for a gold mine of information when it comes to personal finances and investments.

    So, what is my personal investing strategy?

    When it comes to investing in the markets, I’m about as boring as can be.

    My wife and I invest primarily in index funds.

    What is an index fund?

    As explained by Vanguard:

    An index mutual fund or ETF (exchange-traded fund) tracks the performance of a specific market benchmark—or “index,” like the popular S&P 500 Index—as closely as possible. That’s why you may hear people refer to indexing as a “passive” investment strategy.

    Instead of hand-selecting which stocks or bonds the fund will hold, the fund’s manager buys all (or a representative sample) of the stocks or bonds in the index it tracks.

    Why index funds?

    The simplest way to answer that one is to direct you to the single greatest investor of our lifetimes, if not ever: Warren Buffett.

    In 2013, Buffett famously instructed that after he dies, his wife’s cash should be split 10% in short-term government bonds and “90% in a very low-cost S&P 500 index fund.”

    Good enough for Buffett, good enough for me.

    For more on index fund investing, check out The Simple Path to Wealth.

    To sum it all up, my wife and I are not active traders. We don’t seek out the newest, hottest stocks.

    We’re pretty boring, actually.

    We simply make regular contributions to our various investment accounts and let the markets take care of the rest.

    As an example, for my daughter’s 529 plan, we chose a passive investment option that’s a mix of stock index funds and bond index funds.

    Our portfolio automatically rebalances over time based on my daughter’s projected first year of college. Essentially, the closer we get to her first year in school, the more conservative our portfolio becomes.

    We chose a similar option for our son’s 529 plan.

    One other note for context: Keep in mind that my wife and I are real estate investors. We own five properties and 11 total rental units. Our real estate investments comprise a major part of our overall net worth.

    How much money do I put towards each of your financial goals?

    Between saving for emergencies, saving for college, and saving for retirement, there are a lot of options. In addition, you may have other short term goals, like paying for a wedding or a house. Or, you may want to invest in real estate.

    So, how do you determine how much to allocate to each goal?

    There’s no perfect answer here.

    The first thing you can do is to spend some quality time formulating your version of Tiara Goals for financial freedom.

    Then, let those goals inspire conversations with your people to help you make the best decisions. This is exactly how my wife and I came up with our financial goals for this year.

    It also helps to attach specific targets to your financial goals, like we did when we estimated how much you should be saving to pay for college.

    I went through a similar exercise with my retirement savings after reading Die with Zero by Bill Perkins.

    Woman thoughtful about work at home office desk laptop wondering whether she is saving too much for retirement.

    As crazy as it sounds, are you saving too much for retirement?

    In Die with Zero, Perkins suggests that many of us are saving too much for retirement at the expense of using that money to live our best lives now.

    It’s one of the most compelling personal finance books I’ve read in a long time, and I highly recommend it. You can also learn more about Perkins and his journey on his socials.

    Perkins is not suggesting that saving for retirement isn’t important. He’s saying that the hard data shows that most of us are over-saving.

    When I read Die with Zero, I used an online calculator to estimate my projected retirement savings. As Perkins would have expected, at our then savings rate, my wife and I risked over-saving for retirement.

    With that realization, I made some adjustments and am now paying down HELOC debt at a faster rate.

    How much should you save for retirement?

    There’s no way to fairly answer this question. Spend enough time on the internet, and you’ll get many different answers. There are just too many variables in play, like what kind of retirement you want and when you want to retire.

    Perkins points out in Die with Zero that most of the advice out there encourages people to save too much money. You might agree or you might not.

    I encourage you to read Die with Zero and make that determination for yourself.

    At the end of the day, whether it’s saving for retirement or other major life goals, the most important thing is that you are consistently generating money fuel for your life.

    Don’t stress yourself out by worrying about the perfect amount to save towards each goal.

    Are you talking about your money mindset these days?

    It’s never been more important to talk to your friends and family about your money mindset. You don’t have to talk numbers to help each other during uncertain times.

    • Are you talking to your people about your money mindset?
    • What types of conversations are you having to help get through these times of uncertainty?
    • Would you recommend any books or articles that have helped you in the past?

    Let us know in the comments below.