053 What You MUST Know About Target Date Index Funds

Hey there, real quick before we jump into the episode, listen, if your earnings treadmill hasn't set you free yet, running faster won't either. Listen, hustle without principles just going to burn you out. So here's what I want for you. I want you to join me for my money machine experience live. It is three free trainings. Deep dive into how to escape the treadmill and build a money machine that actually works for you. All right, grab your spot here by going to moneymachinelive.com and I'll see you in the free training. We've all heard the talk about invest in index funds, invest in ETFs, and then there's this whole thing of target date index funds. What the heck are they? Here's the thing. If we don't know what target date index funds are and we just go into them blindly, it could cost you your lifestyle. Welcome to this episode of the Affluent Entrepreneur Show. And let's talk about target date index funds. See you in the episode.

This is the Affluent Entrepreneur show for entrepreneurs that want to operate at a high level and achieve financial liberation. I'm your host, Mel Abraham, and I'll be sharing with you what it takes to create success beyond wealth so you can have a richer, more fulfilling lifestyle. In this show, you'll learn how business and money intersect so you can scale your business, scale your money, and scale your life while creating a deeper impact and living with complete freedom. Because that's what it really means to be an affluent entrepreneur.

Hey there. Welcome to this episode of the Affluent Entrepreneur Show. Today we're going to talk about target date index funds. All right, what are they? And you know, we've talked about index funds and ETFs. In fact, I did a deep dive on how to invest in index funds on episode 25. I'll hook that up so you can check it out. It's called how to how to invest in index Funds. But here's the thing. There's this special kind of index fund that people are talking about and you actually see it in 50% of most retirement plans offer these are called target date index funds. In other words, it's an index fund with a date on it. In other words, the date that you want to use the money. So if you want to understand what index and ETFs are, go to episode 25. But the bottom line is this is that an index fund or an ETF is a basket of investments. In other words, you're not investing in one stock, you're investing in multiple stocks. At the same time. And so here's the thing, when we invest, because I like, I just got a text from a dear, dear friend. He says, hey, what are you investing in? Things are on sale because of the volatility in the market. And he's right, things are on sale. And what he's looking for is what companies am I investing, what specific companies I'm investing in. And one of the challenges is that now I invest in individual stocks here and there. But that's not the majority of my investing. That's the slice of my investing after I built the foundation, the portfolio following the wealth priority ladder and all the basis there. Now, because here's what I found, if you invest in a single company, you narrow your focus. Now, great. If it's a high growth company goes to the moon, your portfolio goes to the moon. But if it sinks to the core of the earth, your portfolio sinks to the core of the earth also. So investing in individual stocks, unless you understand specifically how to analyze the company and even then understand how to analyze the company, it's called fundamental analysis and how to analyze the charts, which is called technical analysis. If you don't understand how to do those effectively, then you take on a tremendous amount of risk. Let me give you an example.

For instance, Facebook. Facebook was up close to $400 a share. And then when they announced their earnings in this last quarter, they announced their earnings and they gave guidance. Now every public company will announce earnings quarterly and they'll do calls and they'll give guidance as to what they expect the expectations are for the future. And when they did that, there was a flattening of their user base, a possible decline of the user base, a possible pull out of the EU because of privacy concerns. There was a whole bunch of stuff they said the ISO 14 impacted them. Well, their stock price dropped $100. In a moment. In a moment, so 25%. But that's not all. It continued to drop since then and is down almost 50% from its high. So imagine this, you think this Facebook is a great stock. So you invest in Facebook, it goes to the moon, it goes to $400 a share like it did then they have this bad earnings announcement and it sinks 50%.

There. Therein lies the problem with investing in a single stock when you don't have a foundational portfolio in place. I'm cool with investing in individual stocks, but what I want you to do is make sure that we're not betting the whole game on that one stock. Most of the time, what I do Is with my clients in the affluence blueprint, especially when they're starting out, is I want them investing in ETFs and index funds. If they're investing in the stock market, then if they're doing real estate, it's a different game. But in this stock market, I want an index fund or an ETF because it's a basket of investments. Facebook would be one stock in a basket of maybe 500 stocks. So when Facebook tanks, the whole portfolio doesn't tank or it doesn't go. It doesn't go to the core of the earth. It doesn't tank as bad. Certainly it affects it. But when you have Facebook is only 10% or 5% or 3% of the index fund, it doesn't have as much of an impact on you as if you invested 100%. So hopefully, hopefully that makes sense for you. So why target date index funds? There are index funds, like I said, that have a date and that date on there, you'll see. And it'll have 2045 in the title. It'll have 2050 in the title, 2030 in the title. That date is the date that you anticipate you're going to need the money. So let's say that you're 30 years old and we're in at the time of recording this, we're in 2022 and you're going to retire at 60 years old. That means there's 30 years on.

Between now and your date of retirement. You would get a target date index fund that is at 2062, 2052. I'm sorry, we're at 2022, 30 years to retirement. So you go to 2052. Why is that important? Because here's what happens. If you notice what we try to do with investing is at the foundation, we invest, invest based on our risk profile and our risk capacity. And we create an asset allocation and an asset diversification profile based on the risk that we want. As you get older in life and you get closer to that retirement, we don't want to take as much risk. So we reduce the risk. And what ends up happening is that we have a portfolio that shifts or changes over time. And you can see it's called a glide path. When you talk to people in the finance game, it's what's the glide path of your portfolio? Let's, let's bring this, bring us home and I'll kind of write this out on, on the iPad. For those of you that they get a chance to watch this is that when we start to pull this together and we're building a portfolio. Here's what ends up happening. Say you're 30 years old. Say you're 30 years old. And at 30 years old, you know, you might. And now these are just arbitrary numbers that I am putting out there. Do not take them as suggestions or what they should be. These are arbitrary numbers and you need to determine what those numbers would be for you and your specific circumstances. Because I don't know your circumstances. And nothing on the show is actual investment advice specific to you. And it's informational so you can learn more and do more research so you can understand how to go about it. Because I don't know your personal circumstances. There's my cya and we can go from there. So let's say at 30 years old, you decide you're going to be a little more aggressive and you're going to invest 70% in stocks. Now those stocks could be us, they could be international, okay? And then you're going to have, I don't know, I'm just, I'm making it up 20% in.

Bonds.

5% in.

In alternatives and 5% in cash. As you get older, as, as time goes on, that's going to change because you're closer to retirement. And so if all of a sudden you're at 55 years old, okay, and you're five years from retirement, the percentage of stock in the portfolio will typically go down. It should go down because here's the thing, the stock market will always go up and down. The stock market is a roller coaster. Long term, the stock market typically goes up 90, 95, 96% of the time. When you look at a 10 year period, it'll go up, but there's still those down years. And the problem is, is if you're getting ready to retire and you happen to retire in a down year, then your portfolio is down, your retirement's down and your lifestyle starts to get affected. So what we try to do is reduce the exposure as we get older so we not. If the stock market goes down, we're not as exposed to it. So what ends up happening is that portfolio that started out at 70% stocks might be down to 50% stocks, okay? And 25% bonds. And maybe there's, you know, 10% in an alternative. So that's where the 85 and 15% in cash, or maybe there's more in real. I don't have real estate in here. We could add real estate in here. But my point is, is that you, you'll See that over time these numbers change, they change based upon your risk profile and your capacity to accept the risk. Well, if we invest in ETFs and index funds or stocks in general, you will have to do what we call rebalancing. That's what that is, is rebalancing the portfolio based upon your risk profile and your risk capacity. We rebalance our portfolios annually, but you gonna want to do regular rebalancing, especially in high growth, high decline markets, age change, lifestyle change. A lot of times when you wanna rebalance.

But yet there's a lot of people that say, look, I don't know this stuff, I don't wanna deal with it, I don't wanna have to deal with it. And there comes in the target date index funds. Target date index funds will do automatic rebalancing for you. As you get closer to the time that you have an index fund that's dated 2050. As you start to get closer to 2050, you'll see that they're constantly adjusting. I'm going to show you a graph in a moment where they're constantly adjusting the makeup, the balance of the portfolio to take into consideration where they are in the glide path, where you are in your life cycle and how close you are to retirement and needing that money. So as you get closer and closer to that target date, they're going to get more and more conservative as, as we go. So before I show you the chart, let's just talk about who this might work for. Because it isn't necessarily for everyone. And I think that there's some, some things we need to be aware of in, in understanding that because we don't just blindly go in. Now first off, it's for those people that just want hands off management. Now if you've been in my sphere for any long, any length of time, or in my community for any, that I don't like hands off. Okay. I believe that you are the captain of your financial ship. No matter what, no matter how many advisors you have, no matter accountants, attorneys, financial people, no matter what your, your hands are on that wheel. You're the one that's directing the ship. We don't hand it off to someone. When you do, that's when problems happen. When you do, that's when, when you, you get caught in the situation, you get blindsided. So it's up to you to make sure that you take a hold of the wheel and you look to the right and left to your advisors and say, help guide me, show me where the pitfalls are, show me where the potholes are, show me where the, where the rocks are that I might hit. Okay, but you make the decisions. That's, that's my belief. But if you want to leave it to someone else to manage for now, you put it into a target index fund. They'll consistently do the rebalancing as they get closer to that target date. Okay. Second, this is for someone that doesn't have unique situations that have, that don't have unique needs, if you will. So maybe you have medical costs or high medical costs because you have special needs or a special needs child. Those are unique situations that we need to think about differently. And so this would be typically for someone that doesn't have unique situations, which kind of goes with this next piece, is that it would also be best for someone that has more stability in their lifestyle. They don't have a huge amount of variability need for the cash, that type of thing. So there's some level of stability. And then lastly, it's for those that just want simplicity. Now, my portfolio is a complicated portfolio. In fact, my, my wealth advisors are looking at it going, oh my God, God, okay. But it's, it's a complicated portfolio that we put together for specific reasons and we'll simplify it as we go. But most people don't need that. Most people need just to have a simple portfolio that makes sense based on their risk profile, their risk capacity, their desires in life, their affluence, vision, as we call it, to make that happen. So it's, it's for those types of people. Now, what are the issues with target date index funds? Well, I think the first one is this, is that expenses, the expense ratios are typically higher. For instance, the average expense ratio on a target date fund is about 1/2, 0.5%, 1/2 of a percentage point. Whereas on a typical ETF or index fund, it's like 05008. Now you're sitting back saying, Mel, 0.5 is really not that much. And you'd be right. But when we do the math over our lifetime, say we have ten thousand dollars, a hundred thousand, a million dollars that starts to, can start to add up to hundreds of thousands of dollars over the lifetime. So it's not insignificant, but.

We may be able to sustain it for, for a period of time and there may be a reason to take on that additional expense, but just know that they're typically more costly. The other side of it is this, and this is where I think is one of the biggest weaknesses. If, if we look at, if we look at what they're doing, they put a target date in place and they sit back and they say, okay, I'm in the, in the 2050 fund. And so they have the target date. And that target date is when you expect to need the money. So they consider the date that you're going to need the cash. Here's what they don't consider.

How long do you need the cash?

Okay, so, so in there, it doesn't allow for you to build a portfolio necessarily, unless you're deliberate and intentional about it, that will sustain yourself from the date that it triggers, 2050, in my example, to maybe the additional 30 years that you're going to live to 2080. And so that's a different calculation. It's a different thing that we need to consider. And when you do, proper financial plan, a proper affluence vision plan, cash resource plan, you're considering not only what you need to give you that true financial freedom, that financial independence, financial security, all of those things, but you're, you're calculating it in a way. It's, it will give it to you not just then, but for the rest of your life. Okay, remember, the idea here with, with the whole affluence blueprint, the way we look at things is that I want to build a money machine, a virtual, if you will, atm, that when I decide to use the machine, I can keep taking cash out of it because I'm not shrinking the machine down. And so in order to do that, we need to understand the cost of our lifestyle. We need to understand what it's going to take to give us money, financial independence, financial security, financial stability and financial freedom in making that happen and how long we want that to happen for. And when we do that, that starts to, to give it power. And so, so the, one of the key weaknesses I think, is that it sets a target date when you get at, when you're intending to get access to the money. You can take the money out anytime you want, unless it's in a Roth, I mean, in an IRA or a retirement account. But it doesn't necessarily consider the length of time you're going to need the money for. And so it doesn't assure you financial independence or financial freedom in that place. The other thing is this is, I think that there's a tendency to say, okay, wipe my hands of it, someone else is taking care of it, and you forget about it. One of the other things that, if you're in my community, you know, I say you are always needing to check the pulse on the patient if we disregard or we don't get into understanding and checking our numbers. And I get it, some people just say, yeah, I'm not a numbers person, I'm not a math person. Your financial freedom, your financial liberation, your financial independence, all of that is on the other side of a math equation. So we got to get comfortable with the basic numbers to make that happen. So the tendency is to say, I put it in a target date fund, I'm not going to touch it, I'm not going to look at it, I'm not going to worry about it. And you forget about it, okay? And then your financial muscles atrophy, just like regular muscles latrophy from lack of use. And so I think that's, that's one of the issues with it. But here's the thing, okay, Let me show you what, what these funds will look like and how, why I think that this is, this is important when you, when you start to understand this is that this is a graph. This is actually from Vanguard on their target date mutual funds. And it shows you how they will change the structure of the portfolio based upon how much closer you get to the target date. And if you look early on, it's got a high percentage in stocks. It's actually almost 90% in stocks when you consider international and domestic stocks. So US and non US stocks. And it stays that way till age 25 or 25 years out, if you will, and years to the target date. So you see that it stays that way. And then there's this time frame that they call transition. And during this transition time frame there's this, this gradual decline of the equities and this increasing of the investment grade bonds. What they're doing is they're reducing the risk slowly over time as you get closer and closer to your target date and they're rebalancing the portfolio on your behalf. This is called a glide path. And then at the time that you hit retirement, early retirement, you'll see that there's still more decline. We were going to make it more conservative and then it just, it kind of flattens out at the, at this very conservative level. So if you look at this, we started out with 90% in stocks and we ended when we're in our late retirement years at 25% in stocks. So this is the benefit of using a target date fund is because they will set a glide path based upon the target target date and you don't have to worry about it. But we have those issues in place so.

Why would we do this? Well, first things first. 50% of most retirement accounts, 401ks. This is what they offer. A lot of times they don't offer much different than target date funds. And the, the point then is this. You have to make two decisions. How much am I going to contribute and which fund, which target date am I going to choose? And then you let them do the work. Now, how much you're going to contribute? We've talked about this. I want you to have 20 to 20, 20 to 30% of your income going into your, into your investments. Okay. Over time. Now, you might not be able to do that at the beginning, but we may need to be ultra aggressive if you don't have much saved and you're in your, in your late 40s, early 50s, mid-50s, because we've got to build that money machine. But at a minimum, I want you to contribute to a point where you're going to get the employer match, get the free money from your employer. At a minimum, we start to do that. And so for me, I think this is actually a great place for people that are just starting out to play to get used to making an investment decision, to get used to watching the numbers, to get used to understanding what stocks are, what ETFs are, what index funds are. To choose the target date that may be effective for you and then invest in it. Now I say that it's a great place to start because here's what I believe, that over time you will be better served by rebalancing your portfolio based upon your specific needs and circumstances and not just some date that's choice in the future. Because if you're one that has no kids or you have One that has 10 kids, there's very different needs and there's def. A very different trajectory that we're trying to, to play to. So my belief is that I would use target date index or ETFs at the very beginning when you're first starting out because it makes it easier. You're not going through all the different ETFs. And what ETF do I do? I do, do I do an eye share? What do I do at the beginning? This point? You just get in the game because I got to get you in the game. We can't win the game if we're not on the field. We got to get on the field to win the game. And this is an effective way to get on the field. But once we get critical mass, now I'm going to say critical mass is A few hundred thousand dollars, call it a quarter of a million dollars, you're hitting 250, $300,000 somewhere in that range. I think that you're actually going to be better served by with working with someone and making sure that you are creating a structured portfolio.

Of ETFs and index funds and other investments to fit your affluence vision, what your lifestyle is trying to accomplish. What is it that we're looking for? We're not looking to just put money aside, to put money aside for money aside sake, okay? We are looking to create a lifestyle. We are looking to create legacy. We are looking to create legacy wealth, to create the money machine to give you the freedom that you deserve so you don't have to worry. And sometimes we start with baby steps and those will be target date index funds. But then when we start to jog and run a little bit, we need someone to shape our stride. We need someone to help us out. And that's when I think that you graduate into using more directed ETFs, index funds and other investment vehicles to move you faster and better towards the affluence vision that you want. So I hope this helps you kind of get a foundation of target date index funds. Go out there. Look at me. You can look at them in Vanguard, td, Ameritrade, Schwab, all of them have them. And if you compare the same dates from different brokers, they're pretty much the same makeup. You can see what's inside of them. You can see how they run. You can look at the trajectory, all of those things, the glide, glide, plath and all that stuff. So here's the thing that I want you to do, all right? If you haven't done so already, you're not sure about index funds. I want you to go to episode 25 on how to invest in index funds. We'll make sure that it's hooked up right here to make that happen. The other thing is that I'd love for you to look at if you're trying to get yourself stabilized and get yourself in a place to build wealth, to create that money machine, to fund an affluence vision. I want you to go to episode 24, which is what to do with your cash. This is going to give you the guidance of what to do with every dollar that's coming in so you know.

That it's doing the right stuff for you, moving you towards your affluence vision. So check those two out. We'll make sure that they're hooked up here or here, I'm not sure one side or the other or in the notes. And if you have questions, if something comes up or you need something around finances, around business, around money, around wealth, do me a favor, send me a dm. Send me a note. Let's get it answered on one of these videos. Let's get it answered on one of these episodes. Let's get you even on the show and let's have a conversation where I can coach you directly. All right? Thank you again for being a part of the community, a part of my journey, the blessed part of my journey. This is gift to me to be able to serve you and know that I'm helping you take steps and strides to your financial destiny. All right? And until we get a chance to see or talk to each other again, always, always strive to live a life that outlives you. Cheers.

Thank you for listening to the Affluent Entrepreneur show with me, your host, Mel Abraham. If you want to achieve financial liberation to create an affluent lifestyle, join me in the Affluent Entrepreneur Facebook group now by going to melabraham.com group and I'll see you there.

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