Happy day to you. This is Ken Kaufman, and I am thrilled that you are here for Episode Number 93, “The Target Date Fund.” Now, this is my fourth episode in a row where I’m talking about some of the principles that are presented in a book written by Paul Merriman and Richard Buck called ”We’re Talking Millions,” subtitle, ”12 Simple Ways to Supercharge your Retirement.”
So the focus of this book is to talk about 12 basic, simple steps that any do-it-yourself investor can take that could potentially be worth millions, if they start early enough and if they follow a discipline and execute on all of these items. So I’ve covered the first nine out of the book, and I wanna talk about the last three today, really two of them. One I’ll go over quickly, primarily because it’s something I’ve talked about several times in the past, and I would just refer you back to some old episodes on the principles that are being taught there.
So today, we’re gonna cover putting simple math to work for you or the concept of dollar cost averaging. We’ll spend a few minutes there. And then we’re gonna just skip over the chapter that is titled, “Minimize the Drag of Taxes.” This talks about, should you have a taxable account or a tax sheltered account, like a Roth or a traditional IRA or 403(b) or, you know, so on and so forth with all those different types of accounts, not gonna spend time there. And then step number 12 is “Use a Target Date Retirement Fund.”
So let’s go ahead and jump all the way back to step number 10 here. “Put Simple Math to Work for You” is the name of the chapter, and it’s teaching the concept of dollar cost averaging. And they start off with a quote from NerdWallet, and it says, ”With dollar cost averaging, you take a lot of the emotion and fear out of investing because where the market goes in the short term is far less important to you, as long as you stick to a regular investment plan.” So this is all under this buy-and-hold mentality that…so say you buy into an ETF at $51 and then the next, it goes to $50, but over the next 40 years, it goes to $1,000. It doesn’t really matter those little price fluctuations here in the short term. And that’s the point that they’re trying to make, as long as you stick to this regular investment plan, which is what dollar cost averaging is.
It’s a very, very simple formula, nothing complicated at all. You set up regular savings. Ideally as they say here in the book, payroll deduction or some other automatic method, like a direct debit from your bank account into whichever financial institution you’ve chosen to use and whichever investments specifically within that organization that you’ve selected for this investment. And then you just keep investing the same number of dollars every time on these regular intervals. And that’s it actually. And the interesting thing is when you do this, you actually can end up averaging with a lower per share price to buy in than if you were to just buy all in one lump sum. And they give a really quick example here, which I think is… I think it’s actually very instructive.
So, in this instance, the authors took four periods, January, February, March, and April. And they said, “In each of those periods, we’re gonna go ahead and invest $100 a month. And in January you bought at $20 a share, which got you five shares. In February, the price dropped to $15 a share, and you got 6.67 shares. In March, the price went up to $18 a share and that got you 5.55 shares. And then it went way up to $24 and that got you 4.17 shares.”
The interesting thing in this process, when you take 20 plus 15 plus 18 plus 24, those are the prices of the entry point into the security in each of those four periods, you add them up and divide by 4 to come up with an average that comes out to a $20 average of the four prices. But what’s interesting is dollar cost averaging is not an average of all the prices you’ve paid because you’re putting the same dollar amount in, but when it goes down in price or when it’s gone down from one interval to the next, you’re actually getting more shares.
So when it goes back up, you have more shares and it basically helps you to continue to put you on this discipline where you’re continuing to buy low. So, in the example here, you actually come out with an average cost per share of $18.69, not an average of 20. And so this concept of dollar cost averaging, I mean, it doesn’t guarantee you profit, but what it does guarantee is that your cost for the shares that you own are gonna be lower than the average of all the prices you pay.
So you look back historically and say the average price was X. If you dollar cost average, because of the way things swing up and down, and like I mentioned, as you get more shares, when it’s down, you actually end up outperforming based on just the average growth of the share price. So if you think this isn’t super interesting, the authors say, they go ahead and they take a really extreme example and they go back to 1929 when the stock market crashed. And we’ve heard about this incident that happened. It kicked the door open to what’s known as the Great Recession and for roughly a decade, there was a lot of economic challenge and economic turmoil throughout the whole world actually, certainly hit the stock market here in the U.S. dramatically.
So they did a study during this period of time to see, “Hey, what would dollar cost averaging have done if back in 1929, I just started investing regularly every year?” And the finding is really interesting. So from this 10-year period, from 1929, when the crash happened to 1938, it was abysmal. If you had put $1,000 in, in 1929, it would have been worth $480, 10 years later at the end of 1938.
So, in essence, your investment would have gone down over a 10 year period, 52%. That’s pretty dramatic, pretty extreme. If you had actually done dollar cost averaging over those 10 years, and you said, “Hey, instead of putting a full $1,000 in, in 1929, I’ll put 100 in. And then in 1930, I’ll put 100 in.” And each year, you put $100 in, look at what happens. At the end of 1938, you would have ended with a profit of $524. So your total account balance would have been $1,524. And you say, “Well, why the economy is horrible and so on and so forth?” Well, because there were several years when it was way down and you were buying shares much more inexpensively with the $100 dollars and $100, again, up to $1,000 over that period of time.
And the first example, when you put it all in, in 1929, your account went from $1,000 to $480. In this case, your account went from that $100. You put a total of $1,000 in and you ended up with $1,524. It’s fascinating, but creating this discipline through dollar cost averaging can actually really, really help to keep you on track and to keep a discipline so that no matter what’s happening in the market, you just have money going in and it’s automated. You don’t have to think about it. You don’t even have to push a button. You don’t have to question yourself, “Well, I read this article last night that said, they think the economy is gonna blow up tomorrow and I’m not gonna put my money in anymore.” All of those emotional elements are removed, nice, smooth dollar cost averaging.
And there’s some cool stats here too. Again, I recommend for you to pick up the book and read it. And that was an unusual case. Those were small cap stocks, extremely volatile up and down and all over. But the point is that in our minds, we’re generally creating extreme scenarios that push us into paralysis or into being overconfident and not treating the market like it should be, which is, it is a vehicle for growth that cannot be predicted. It will go up. It will go down. It will go sideways. It will stay flat for years. There’s no one that can tell you exactly what’s gonna happen in the market. We just know that over time, it has always ended up going up, no guarantees and no promises. You guys know that all I’m doing is stating facts of exactly what’s happened in the market over the years.
So, in this case, we don’t know the future. We can’t guarantee that there’s ever gonna be any reliable sign that will indicate that we should get in or get out of the market. You just never know, dollar cost averaging makes you, this is from the authors, “more likely to succeed as an investor by forcing you to buy more of an asset when the price is relatively low.” And if dollar cost averaging reduces or eliminates your desire to tinker with timing your investments, well, that could actually be worth quite a bit of money because those who tinker end up having portfolios that perform much, much worse than the indexes or the market averages.
So jumping on to step number 11, you want to minimize the drag of taxes. Again, as I mentioned at the beginning of the episode, this is mostly about selecting the right account type. And then, once you get the right account type, then putting the right investments in those account types and doing everything you can to minimize taxes, not to avoid taxes. This is all legal, and there are just strategies around how you can best position your assets to minimize the taxation of them while they’re trying to grow for you.
And then I’m gonna jump. So I’m jumping ahead now to point number, or to small step number 12. And this one is titled, “Use a Target Date Retirement Fund,” which is also the title that I went ahead and put on this episode. NerdWallet says, ”Target date funds are a set-it-and-forget-it retirement savings option that removes two headaches for investors. One, deciding on a mix of assets, meaning stocks and bonds and all those sorts of things and number two, rebalancing those investments over time.”
Now, this is a bit contrarian as some of the other small and simple steps mentioned in this book to conventional wisdom. Because if you look today at a 5-year return or a 10-year return, a lot of retirement date funds have underperformed the S&P 500, have underperformed other asset classes. But when you go back and look at longer term, you can see there have been a lot of times where retirement date funds have done quite a bit better. The concept here is that the retirement date fund, [inaudible 00:10:40] fund, takes on a bunch of different things and it solves steps number three through step number seven by just using it and not needing to think about it. It’s just done and it’s handled for you.
Now, there are some elements to be careful of, but let me go ahead and highlight this. If you remember at the beginning of the book, step one and step two, it was start saving money and start saving money early. Like basically spend less than you make and save it, and then start putting this money away and saving early on in life. It doesn’t solve those two things. But it solves step number three, by getting you invested into stocks over bonds if you have a long-term horizon ahead of you.
Step number four, you’re gonna invest in hundreds or even thousands of stocks, not just a small few. When you invest in these target date funds, because they generally are broadly invested, but a lot of times they’re index-based.
Step number five was about keeping your expenses low. And there are a lot of very inexpensive target date funds available through Fidelity, Vanguard, Schwab, T. Rowe Price, and so on.
And then investing in index funds. Yeah, a lot of these target date funds, that’s where they’re investing is these index funds. So that’s step number six.
Step number seven is where you should really get some exposure into small company stocks. And this definitely does that for you because it’s purchasing indexes, which are big blocks of different companies that are publicly traded.
Step number eight, you will invest in value stocks because, again, small cap and value stocks over time can produce better returns. Now, again, no promise or guarantee, they’re just relying on what what’s happened in the past.
Step number nine, the concept of a stay away from market timing. That’s what this is. There’s nobody trading or moving money back and forth between different investment options and these retirement day funds. They are set, they’re locked, loaded in index funds and you’re not gonna have anybody trying to time or move more to bonds or more to stocks when they think certain movements are gonna take place in the market or selling short or anything of that nature.
Step number 10 that we just covered is this concept of dollar cost averaging. Again, you can set it so you have $50, $100 money coming out of your paycheck, whatever it is into this target date fund, and it gives you the ability to just buy these small fractional incremental shares of all of these different stocks that are helping you accomplish all of these simple steps that are laid out in the book.
And then step number 11 to avoid high taxes, the target day funds are not trading actively. They’re not trying to beat market returns. They’re not trying to do any tax loss harvesting. They are focused just on invest in the indexes, buy and hold, let it ride. And so that generally helps to avoid higher taxes because there’s a lot of turnover in the portfolio.
So that’s a lot. These were stated as simple steps that you could go and do all [inaudible 00:13:48] on your own, but it actually, the step number 12, solves almost everyone except for starting early and learning to save money and put it aside.
So I’ll now talk for just a second about these target date funds. And you can go to a, you know, a Charles Schwab or Fidelity or Vanguard, and you can buy a mutual fund or an ETF that would represent one of these target date retirement funds. And when you do that, and there’s nothing wrong with it, that’s good. The challenge is that they do pre-select what your bond and what your stock allocation is, and they usually have dates on them and they’re in five-year increments. So it might say 2025, 2030, 2035, 2040, and so on. And generally, you wanna pick the one that has the year that’s the closest to when you’re expecting to retire. And it’s making assumptions about how much risk you wanna expose yourself to.
Now, I am willing to expose myself to more risk than a target date fund that would be for my retirement. So generally, I’m investing in a target date fund, probably that a 25-year-old would invest in if I was to be choosing that or, you know, somewhere in that range. And still that probably wouldn’t, say, shave me because I would think that it has too much fixed income in it. Again, that’s personal preference for me.
What I have done, when it comes to this, is I’ve basically built out a portfolio and it’s based on a lot of the same work of these authors, Paul Merriman and Richard Buck. But the concept is that this target date fund or, I’m sorry, what I’ve done is actually expanded access to different asset classes that, in my opinion, makes sense to have, besides just what fits inside the target date fund. And to give you an example, right now in my retirement funds, now, this is besides what’s in a company 401(k) where I just have, I actually am in a target date retirement fund there, but I have other retirement assets. In fact, the lion’s share of it is outside of an employer-sponsored plan.
And in those, I make sure that I have large cap blend. I pick up those assets. I pick up large cap value, small cap blend, small cap value, real estate, investment trust, all within U.S. markets, and then picking up similar types of securities that are domiciled internationally. And then there’s bonds that are split between short and medium and long-term government bonds, and Treasury Inflation-Protected Securities, or what are called TIPS that protect against inflation eroding the value of a bond as interest rates fluctuate.
And so, by doing that, I’ve basically created my own target date fund. I pick how much I want in equities, how much I want in bonds, and what my comfort level is relative to the risk I’m willing to take. And in essence, all that is, it’s just a little bit more complex. You can then a target date retirement fund that you would buy where you just go into one security, this one I’m going into 5, 10, there’s 13 different securities. And then I’m taking on all the work of rebalancing it myself and making sure that it’s been done in a tax efficient way and all of those other things.
So really, the target date fund is brilliant. You can make it complicated like I do, or you can keep it really simple and just go get one of these index-based retirement date funds. Find the one that’s closest to your age, your retirement, or look at it. And if you want more stocks in it than it has, or if you want more bonds, you can move up and down the ladder in these five-year increments and pick which one you want to run with.
So this is really a summary of these 12 points. There are a few more things I’ll probably in a future episode talk about that come out of the book that I think Paul Merriman and Richard Buck do a great job of articulating. The point here is there are these simple things that all of us can do to be really savvy, smart, and ultimately, successful do-it-yourself investors. And the point of going through this book and sharing some of these key principles is to hopefully, first of all, show you, these are really small and simple steps. They take a little bit of discipline. But then there is actually a great solution via the target date fund that takes very little work.
And then, like I said, in a future episode, I’ll get into how they go one step further. Instead of just investing in the target date fund, they actually add one more fund that you can get access to that will help you achieve, at greater size, the exposure to value and the exposure to small cap that can make a lot of sense, especially for younger investors who have got a lot of time to handle the volatility that, over time, these securities can end up creating or generating higher returns. But you have to be willing to stomach some of the more aggressive ups and downs of other, say, large growth stocks or larger companies.
I hope this has been helpful. Many, many thanks to you for joining today. This is a wrap for Episode 93. Happy day.
