The Skinny on Target-Date Funds

One area of retirement planning that has gone viral is the emergence of Target-Date Funds (TDFs) or Life-Cycle Funds. These funds accounted for roughly $12 billion in assets as of 2001 and now hold over $400 billion in assets. The drastic rise is a result of many employers auto-enrolling employees in these funds, which was made possible thanks to a federal law passed in 2006.

Let's first examine what a TDF really is. It is nothing more than a mutual fund, usually made up of various other funds, that each specialize in something different. The key to a TDF is that it is suppose to become increasingly conservative in its investment allocation, as the targeted date approaches. TDFs are normally broken up by five-year increments (i.e., retirement date 2025, 2030, 2035). A 2040 TDF, for example, would represent a fund built for someone wanting to retire in the year 2040. As we get closer to that year, the fund should get more and more conservative to protect the investor from large market fluctuations as the client nears retirement. At least that is the theory.

There are pros and cons to these funds, so we will hit some of the main points below.

Target-Date Fund Advantages

• Easy - set it and forget it investment tool. An investment manager or management team will select a mixture of other funds that should be shifted automatically from aggressive to more conservative, as you near retirement.  

• Diversity - provides a fair amount of investment and asset allocation diversity with one fund pick. That being said, each TDF has their own idea of diversity and allocation, so look at their holdings to make sure their ideals line up with yours.

Target-Date Fund Downfalls

• Fees - in exchange for making these allocations on your behalf, an additional fee will be levied on you. These additional fees average roughly 0.75%, according to a recent Brightscope TDF survey. This could cost well over $100K in additional fees over a 30-year career of saving for retirement.

• Allocation risk - exist because there are no set standards for TDFs. Fluctuations in allocation (which directly affect how volatile the fund can be) percentages can vary wildly from one fund to another. This means, for example, that all 2045 Target-Date Funds are not built equally. Each managing team can determine their own strategy. Some may be 40% equity and 60% fixed income, while others of the same target-date year will have the exact opposite allocation. This can definitely affect the volatility of your nest egg and how much sleep you get at night.

• Conflicts of interest - are easy to see here. Because of the ease of getting money into TDFs, fund families can easily add assets to less popular funds in the fund they want to grow by including them in a TDF. In addition, fund families might be swayed to hold larger equity positions (stocks, which can be volatile) than most investors would be comfortable with, as equity funds can typically charge higher fees than most fixed income funds do.

• Suitability standard - allows TDFs to operate in a manner less stringent than fiduciary care. In other words, the client's interests do not have to come first...by law. The fund management just needs to show the investments are "suitable" for the average person. 

The Bottom Line

 

TDFs can be a beneficial tool for many investors. Do they provide access to the best funds, the lowest fees, and the perfect allocation for you? Probably not. Do they prevent you from potentially making more costly errors yourself? Very likely. All in all, you could probably do better than a TDF, but you would also have to be willing and disciplined enough to put in the time to monitor and appropriately adjust your portfolio on a regular basis.

The key ingredient to building your portfolio for retirement is that you save, save, save! After that, having a good management plan can help you get all the mileage possible out of those funds, but the plan comes second to making sure you set aside funds to make it possible. Invest well!

Get Your Full Tax Deduction

To the dismay of some of our friends over the years, my bride and I have been saving every receipt we can. Are we keeping these for a weird scrapbook of financial mementos? Negative - we aren't big at scrapbooking...though I kind of wish we were. We use these receipts to calculate the total local sales taxes we have paid throughout the year and get a deduction for this amount when tax time rolls around.

Our trusty receipt organizer.

There is a law in the books that allows taxpayers the choice of deducting the state and local income taxes paid or the general state and local sales taxes paid. This choice is a no-brainer for residents of Texas, Florida, and other states without state income taxes. Note: this option is only available to those of you that itemize on your tax return. If you claim the standard IRS deduction, you cannot take advantage of this. 

So, you are an itemizer and you want to get your hands on this deduction? Well, you have two options on how to come about this deduction amount. Option 1: You can save receipts and calculate the actual number based on your purchases throughout the year. Option 2: You can use a generic number from an IRS table based on your state of residence, income, and exemptions claimed. If you use this table, you can also add sales tax paid on a car or certain other large purchases. 

Hopefully this will help a lot of you lower your tax bills this year and potentially become a receipt collector in 2012! Save, and invest well. 

Keeping an Eye Out for (Money) Predators

There are few (financial) stories that make me boil up more than stories of parents or grandparents being taken advantage of by "investment advisors." I have seen this firsthand and have heard many more times, stories of retirees being victimized by people they thought were helping them with financial matters. Recently, I came across an article published in Money Magazine, by Lisa Gibbs, that gave fantastic advice on this issue. The article focuses on the various pitches that these leeches employ and tips on how you can help protect against them. Unfortunately, it's not as easy as just applying bug spray.

Below is my shortened (think CliffsNotes) version of the article:

Pitch #1: "It's a free lunch (or dinner) seminar" - Nearly 60% of those surveyed by an AARP survey reported receiving five or more invitations in the past three years. Many actually attend these in hopes of finding answers, and instead are fed generalities and then pushed hard for follow up appointments.
How to help - (a) Sounds simple, but talk to your parents about these and ask them to "just say no." (b) Engage your parents in financial conversations and if they are worried about a particular area, help them find a trustworthy expert and address those concerns proactively. (c) If you can't talk them out of it, go with them. If logistically you can't go, give them AARP's free-lunch checklist to help them identify these potential scams.

Pitch #2: "I can help ease your mind" - Some agents for high fee annuity products are taught to get "in the door" by tapping into worry areas of unsuspecting retirees. Fear is a common and powerful persuasion tactic that makes it even more difficult to process information and make decisions rationally.
How to help -  (a) Do your best to eliminate cold calls by getting them on the Do Not Call list (donotcall.gov or 888-382-1222), and cut unsolicited junk mailings at dmachoice.org. (b) For phone calls that do make it through, practice ways to quickly end the call - even if it is as simple as saying, "No, I'm not interested," followed by hanging up the phone.

Pitch #3: "I'll be your new friend" - Finding common hobbies or talking about children are both used to build that trust factor. Once that is established, the sales pitches become easier. This technique is most effective with seniors who live alone or are far from family.
How to help - (a) Stay in the know and ask parents about their friends or activities. Be careful here, in your responses. You don't want to yell at them or let the conversation become negative. This could help reinforce a thought that their new friend is the only person they have enjoyable conversations with. (b) Ask the family physician to be attentive to signs of money issues...and to warn of potential scams, if the patient/doctor relationship is appropriate.

Pitch #4: "I can get you 8% or 10% or more" - Guaranteed high returning investments are a red flag. Investment products promoted this way are usually risky, carry large hidden fees, pay the salesperson a handsome commission (which entices him or her to use any and all sales methods), and could lock up funds for a significant period of time. Keep it simple, and remember, in all investments there is a risk and a potential reward. These two things move opposite of one another. You can't have both.
How you can help - (a) Be inquisitive and ask questions. Can you fully understand the product? Can you get money out, without penalty? Get any facts or figures in writing. (b) Use the "free look" period to cancel the policy. Buyers of insurance products (annuities) typically have a 10- to 30-day period when they can cancel for a full refund. If that doesn't work, your state insurance regulator might be able to help.

Pitch #5: "You must act now or call today" - Creating a false sense of urgency is one of oldest tricks in the book and still one of the most popular. A top regulator in Colorado said that this tactic shows up in virtually all of the cases his office handles.
How you can help - Suggest that your parents always get a second opinion on ANY significant financial decision. Legitimate financial plans or offers should not require an immediate decision. Whether the second set of eyes are yours or a financial planner's, make sure someone trustworthy gives some feedback.

You have read the high points, but if you want to view the article in its entirety, you can click here. Great job, Lisa Gibbs, from Money Magazine. Invest well!