Monday Sunday is back for this Mother's Day, after a long hiatus. Money Sunday provides Kossacks with a progressive view on the economy and personal financial planning. After all, there's nothing better than thousands more wealthy progressives who can devote more financial resources toward improving our nation and the world.
This month features details about a relatively new class of mutual funds: the "automatic" retirement funds. These funds can play an important role in your personal financial success, especially if you are like most Kossacks: too busy with more important issues to spend countless hours managing your money. Regardless of your age or income, read on for details and for links to past Monday Sunday articles....
Monday Sunday briefly mentioned the automatic mutual funds on April 17, 2005, but these funds deserve their own, separate article because they're so useful for personal financial planning. Some people consider these funds to be "derivatives," but don't let that word scare you. These automatic retirement funds typically have these characteristics:
- A single fund that invests in multiple other funds, usually index funds.
- This derivative fund is available for your particular target retirement year, to the nearest decade or half decade (e.g. 2025, 2035, 2045, etc.)
- Initially the fund invests mostly in higher risk stocks, but over time the fund automatically, gradually adjusts to favor less risky bonds and money market funds.
I should say up front that many "investment professionals" hate these derivative funds, because they are basically "fire and forget" funds. The idea is that you can invest a certain number of dollars each month (such as a paycheck deduction) and the fund managers will automatically make sure that your money is invested in an age-appropriate basket of other mutual funds. When you're young and have many years left until retirement, you don't mind a higher risk in exchange for a potentially higher reward over time, but as you approach retirement you want more stable income. That's the power of these funds, and because of the way they operate they generate no "churn" (and thus brokerage commissions). You do not have to manually buy and sell funds, stocks, and bonds in order to rebalance your portfolio. The fund managers take care of that, and with billions of dollars they can get excellent rates on their trading.
Many mutual fund companies offer these automatic funds. My favorite is Vanguard's Target Retirement series of funds, and another favorite is TIAA-CREF's Lifecycle series. Both fund families are no load (meaning you do not pay a brokerage fee to buy them), and both have low money manager expenses (although do shop around).
These target/lifecycle funds are appropriate for just about everyone, especially for most of us who are not money management experts. I recommend dollar cost averaging your contributions into these funds: set aside a payroll deduction if you can. However, be sure to take advantage of any 401(k) matching funds your employer might offer and the Roth IRA first. You can invest your Roth IRA in these funds, and your employer may offer these funds as a choice within your 401(k) or similar workplace program. And remember to protect your highest yielding funds in the tax advantaged 401(k) and Roth first. As you approach retirement age, the target/lifecycle funds may not be your portfolio's highest yielding investments.
You can also use these funds to support major future purchases, such as college education or home buying. Just buy the target fund matching the year when you expect to pay for this major purchase. In the case of college education there may be other investments that have tax advantages that are worth considering, but you could do a lot worse.
The fund companies vary in how much risk they incorporate into their target/lifecycle portfolios upon reaching the target year, so be sure to read the investment materials carefully to understand whether that level of risk matches your goals. You can augment the target/lifecycle fund's characteristics by purchasing other, traditional funds. For example, if you want more risk at a certain age, you can put some additional money in a separate international stock index fund, for example. Conversely, if you want less risk, you can combine some money in the target/lifecycle fund with an additional investment in an inflation-protected bond index fund, to pick another example. But even so, having the automatic fund in your portfolio means you can spend less time rebalancing, because a substantial fraction of your overall portfolio is already changing as you age. That's what I do: I use the target fund in order to put more of my portfolio on "automatic pilot," but I still need to pay a little attention to the rest of my portfolio to make sure, overall, everything makes sense for my life situation.
Some of the money managers point out that it can be difficult to compare target/lifecycle funds with one another, to determine how well they perform compared to the market and compared to other funds. I suppose that's true, but that's not a unique problem, and the two highly regarded fund companies I mentioned provide details on how they are managing these funds. Vanguard's funds, for example, invest in a mix of their own traditional index funds, so you can evaluate whether those underlying index funds perform well.
Another potential problem is that it takes some money to get started with these target/lifecycle funds. Vanguard, for example, requires $3,000 to open an account (less with certain retirement plans). Thus these funds may not be appropriate if you are just getting started. However, if you can set aside just $60 a week for one year, you'll have more than enough to buy in.
And that's today's Monday Sunday. Be sure to read past editions (and comments) to brush up on your progressive financial knowledge. You can also see how Monday Sunday's predictions over two years ago were absolutely spot on. For example, in the housing bubble article, Monday Sunday advised locking in fixed interest rates, downsizing if you were struggling with mortgage payments (to sell at the top of the housing market), and avoiding new home purchases at that time. Wow, was that good advice!
May 8, 2005: Is There a Housing "Bubble"?
April 24, 2005: Saving with Little or No Lifestyle Impact
April 17, 2005: Stocks Down (Again)
April 10, 2005: Enjoy Credit Card Rebates
April 3, 2005: Dealing with High Oil Prices
March 13, 2005: Declining Dollar, What to Do