- I was recently going
through a Vanguard 401k report of 5 million investors when one thing really stuck out at me, the
use of target date funds has skyrocketed over the past 10 years. Now, I've pumped a three fund
portfolio and talked trash about target date funds on
this channel for many years. But it got me thinking,
why even waste your time with a three fund
portfolio when you can make your life a whole lot simpler by just investing into
one target date fund? So is it time to completely
abandon a three fund portfolio in favor of a target date fund? Let's find out. A three fund portfolio
consists of, you guessed it, three different index funds
or the equivalent ETF. It's made up of a total US stock fund or S&P 500 fund, a total
international stock fund and a total US bond fund of some sort. The goal of this type of portfolio is to diversify
your money globally with a small number of funds at one of the lowest total costs possible. A target date fund, on the other hand, is one fund to rule them all,
"Lord of the Ring," style. It generally rolls up four different types of funds into one, a total US stock fund, total international Stock
Fund, a total US bond fund and a total international bond fund. The goal of a target
date fund is to give you a globally diversified portfolio
within one single fund. It's unique in that as you move closer to the
target retirement date, this type of fund will adjust your stock and bond allocation to
move more of your holdings towards bonds based on
the target date you chose. How the holdings move
over time is based on what's called a glide path. As you can see, this is how it works for Vanguard target date funds. In your younger years, more is allocated towards
stocks, then slowly decreases over time as you move into and beyond the target retirement date. When it comes to executing the
initial process of investing in a target date fund
or three fund portfolio, the target date fund is the clear winner. With the target date fund, you only have to worry
about buying one thing. This is perfect for people
who don't in this slightest, care about investing, but
know how important it is. With a three fund portfolio, on the other hand, you
have to go out of your way to pick the three funds
and set the allocation. In my opinion, you should
have a basic understanding of asset allocation if
you are going to invest in a three fund portfolio so
that you can feel comfortable with what percentage you are
going to invest into each fund. But this can be easily
understood by reading this book or watching my video on the topic. Is the three fund portfolio easy to start? Absolutely, but at the end of the day, it's a little more work
compared to a target date fund. When it comes to managing and
maintaining each portfolio, the target date fund
should be the clear winner but technically, I can make a case for the three fund portfolio
being just as easy to maintain if you do one specific thing. The TDF will of course,
manage itself as time goes on since everything is bundled together. With a three fund
portfolio, as you add money, you'll have to choose how
those dollars are spread across the three funds, based
on the target allocation that you've chosen ahead of time. If your three fund portfolio is made up of traditional index funds
through Vanguard, Fidelity or Schwab, then you'll have
to manually do the math on your own so you know how
much to buy of each fund, which is a little more work. The other option with
these three platforms is to have your money spread across
the three funds automatically. But the main issue when you set it up to be done automatically through these platforms
is that you can only choose the dollar amount
that you want invested into each fund ahead of time. The reason this could be an issue is that the market price of these
funds is constantly moving. So when you buy the funds, you might be over or under
allocating your money, compared to your target allocation, based on where the
market is at on that day. Now, this can easily be
avoided when you do your once per year rebalance, but
ideally when you invest, you'd like your money to
automatically be spread out, based on which funds have too
much or too little in them, based on your target
allocation throughout the year. The best solution that
I've found to this is if you create an ETF-based
three fund portfolio through the investing platform M1 Finance. They do something called
dynamic rebalancing. When you invest each month, they'll automatically spread your money across all of your investments, based on the predetermined
allocation that you've chosen. Here's a little real life example of what I mean by dynamic rebalancing. The target allocation I've
chosen is 94% total US stock ETF, and a 6% total
international stock ETF. As you can see, the market
has moved since the last time I invested within this account. So the allocation is out
of whack because 94.9% is in the US stock ETF and 5% is in the international stock ETF. M1 Finance knows this. So if I had the account set
up to auto invest, say $1,000, then as you can see, it's
going to invest more than 50% of that $1,000 into the
total international stock ETF to get my allocation
back to that 6% target. Then invest the rest into
my total US stock ETF to keep it at 94%. If you create an ETF-based
three fund portfolio through a platform like M1 Finance, then I would consider it to
be just as easy to manage as a target date fund. A three fund portfolio is
great for those investors who want more control to tweak
how much they have allocated in each fund for many different reasons. Reasons like we're all at different spots in our personal lives when
it comes to account balances, how many years until
retirement, risk tolerance, tax situations and whatever else. These might all cause
an investor to want to have more control over their portfolio. With a target date fund, you're
locked into the allocations they choose for that
fund and that glide path. To be fair, if you're
someone who wants to be say, aggressive with the safety
of a target date fund, then you can choose to invest in one with the furthest year out. So if the current one is 2070, then invest in that fund until
the 2075 fund is released. At that point, sell off your 2070 fund and buy the 2075 fund if you want to keep your portfolio
a little more aggressive. I'll talk more about tax
consequences in just a minute but you probably only want to do this in a tax sheltered account and not a taxable brokerage account. Shoving money into our portfolios during the accumulation phase of investing is the easy part, but at some point we're
going to be living off of that money so we need to be thinking about how we're going to
unwind our investments as we need money to live
off of in retirement. Some of you in your
early 20s could care less and I get it, but for
us in our late 20s, 30s, 40s and 50s and even 60s, we need to be thinking about this. With a target date fund, you only have to concern yourself
with selling off one fund when you go to withdraw
money for retirement. It doesn't get much easier than that. With a three fund portfolio,
you have to choose between which three funds to
sell off and at which amounts. There's different strategies
that you can use to do this, which makes it a little less difficult. But from a simplicity perspective,
a target date fund wins because you know, one
fund is easier than three. Now, you could utilize
both a three fund portfolio and target date fund by doing something like using a three fund portfolio during the accumulation phase, then swapping over to a
more hands-off TDF approach, closer to and in retirement. Or you can do the opposite,
help support my little dog, Molly and this channel by
hitting that thumbs up button. Quick side note, you should try to avoid
holding a target date fund in a taxable investment
account and only hold them in tax sheltered retirement
accounts if possible. I'm not gonna go into all the details but it mainly has to
do with how these types of mutual funds are set up
from a legal and tax situation. They have to distribute net
capital gains and dividends, which could cost you some money if it's held within a
taxable brokerage account. We got a real life case study
for how bad this can get, back in 2021, when Vanguard made a change and it cost investors a lot of money if they held these funds
in a taxable account. I know someone personally
who got screwed over by this but if you wanna read more
about it, then you can look up Jason Zweig's article, where he covered it in more detail. Now, if you're someone who is just in love with the idea of investing
in a target date fund within your taxable investment account, then you can always kind
of build one on your own. You'll have to do this by looking at the target date fund that
suits your needs right now. Then buy those types of ETFs or index funds individually
within your taxable account. Once again, M1 Finance is a good platform to make this strategy easy. The target date fund tells
you exactly which type of allocation percentage
to put towards each one so it's simple to copy. The only thing you'll
have to do is manually adjust the allocation over time, based on what that target date fund does. This is a little more work since you'll wanna understand
how these allocation changes impact your personal
tax situation over time but it's as close to a manual target date
fund as you can get. I'm the guy on YouTube who
doesn't shut the heck up about paying attention to the
fees involved with investing because I hate seeing
people basically become poor because of the fees they charge. The fees for a three fund
portfolio are generally going to be a little lower than a target date fund, but
to be honest, the 0.08% fee a target date fund charges
versus an average 0.04% fee for a three fund ETF portfolio
is so insignificantly close that it's barely even
worth considering here. There's more fees to look out for, which I'll cover in just
a minute to hang tight. Depending on where and which
fund you buy, there could be minimum initial investment
amounts needed to buy both a three fund portfolio and a target date fund. With a three fund portfolio, here's a quick breakdown
of minimum amounts charged for index funds and ETFs
on different platforms. Vanguard gets a big L since there is a minimum investment amount to hold their index funds. Seriously. Vanguard, a newer investor would need at least $9,000 to
build a three fund portfolio of index funds on your platform, which is not realistic at all. Get the heck outta here. It's one of the main reasons I've started holding Vanguard ETFs on M1 Finance over the past few years. FYI, to avoid paying any unnecessary fees only by Vanguard, Fidelity and Schwab index funds on
their respective platforms. If you try to buy, say Vanguard index funds on
the Fidelity platform, then they'll charge you an additional fee. So don't do this. Here's the minimum
initial investment amounts for each platform when it
comes to target date funds. Once again, Vanguard is the
biggest loser, which annoys me. When it comes to where
you can buy each one, there's pros and cons to
both a three fund portfolio and a target date fund. Each fund in a three fund portfolio can be purchased wherever they're available. Within a company
sponsored retirement plan, it could be hit or miss. Depending on the investment options your employer has chosen, you may or may not have access
to all three types of funds. Even if you do, you need to be careful because some of these
funds are actively managed or littered with very high fees so it might not make sense to
build a three fund portfolio in this type of account. In a 401k from one of
my previous employers, they offer a good low cost,
S&P 500 and bond option, but they only offer a high fee, actively managed international fund. So building a three fund portfolio within that account isn't
something that I'm gonna do. I have a whole video, where I break down the true cost of investment fees, which I'll link up in the
description down below and at the end of this video as well. That video has already
saved viewers hundreds of thousands of dollars so you should definitely
get some value out of it. When it comes to where a
target date fund is available, you should definitely have them in an employer-sponsored retirement plan. While most of them are low cost, once again, you do have
to watch out for ones that charge very high fees. Also, keep in mind that you can always try to
make a change if you notice that your employer-sponsored
retirement plan is littered with high fee and or
actively managed funds. Most of the time, these
administrators don't really understand how
much high fee funds are costing the employees. I've come around to target date funds because I think they're great
for anyone just starting out, who doesn't want to
make too many mistakes. We all know how important
it is to get your money invested as soon as possible. So going this route, at
least in the very beginning, is going to give you the
ability to get your money in the market, to buy yourself
time to do more research on if it makes sense
for you to use something like a two or three fund
portfolio later down the line. I was recently working with a 22 year old girl, who
is doing this exact strategy. Maybe she'll wanna move
to a more customized, two or three fund portfolio
in the future and maybe not. Either way, her money is working for her and that is better than just
sitting in her bank account. Some of you might think
that her having 10% bonds at 22 is way too conservative,
but let's be honest, this isn't going to destroy
her long-term returns enough to throw up any red flags. Plus, anyone who understands investing, even just a little bit knows that your time is better spent
increasing your savings rates versus trying to eek
out an extra one or 2% of investment returns. At the end of the day, I'm now on team three fund
portfolio and target date fund. YouTube thinks that you
need to watch these videos to your left next, free M1 Finance bonus, down in the description below,
hit that thumbs up button to help support the free
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