Target Date Retirement Funds Pros and Cons

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Target date funds have been around for two decades now and they continue to evolve and find their place in more and more portfolios. The funds are typically inexpensive and give you a great amount of diversification while targeting an appropriate amount of risk to fit your financial timeline.

When target date funds were introduced they were designed for 401k plans as an end-all-be-all investment for participants. Now these investments seem to make their way into most portfolios, across multiple accounts, and sometimes appear as a single investment in an entire portfolio. Target date funds are actually very versatile, becuase these funds follow a “glide path.” This basically means that, as the target date approaches, the funds’ allocation tends to glide down a path to a more conservative allocation. Since their introduction, target date funds have become more efficient, more affordable, and more diverse.

To show how popular these investments have become, consider this, in 2013, 1/3 of net flows to mutual fund companies have been into target date funds. Check out the statistics for the three largest target date fund companies in the market:

Percentage of net flows that are invested in target date funds:

Fidelity:                50%
Vanguard:            16%
T. Rowe Price:     95%

Since the great recession, most target dates funds accelerated their downward glide path to a more conservative allocation. Pre-2008 equity exposure for close-to-retirement based funds have seen decreases in equity exposure from upward of 50% down to 35%. We have seen this trend of target date funds that are within 5 years of their target becoming much more conservative, with the exception of the Fidelity Freedom Funds, who have increased equity exposure from their previous norms.

Brian and Bo love target date funds when starting out, because of the ease and sophistication that comes in one holding. At some point, though, when you start adding multiple accounts, larger amounts of money, and bigger tax implications, more advanced planning is advantageous.

ConsumerReports did a great article on how to select the optimum target date fund for your situation. Most of the data in the show comes from Morningstar’s annual target date webinar and their 2014 Target Date Series Research Paper.

How Much Insurance Do I Need?

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Brian and Bo discuss insurance necessities as well as the appropriate level of insurance to carry across varying career and life stages. The guys also discuss emergency reserves and disability insurance. If you are in the market for insurance this is the show for you!

First, everyone agrees that you should have 3-6 months of emergency reserves on hand, but which end of the spectrum do you fall into? If you work in a highly marketable industry where jobs are plentiful, 3 months is probably the best way to go. However, if you have children or you’re married and only one spouse is working or some variation of the two, it makes sense to carry a higher level of cash reserves. Say, 6 to 9 months of total expenses.

Second, statistics show that 50% of foreclosures are the product of a disability. Also, the likelihood of becoming disabled is much greater than dying prematurely. So, how much and what kind of disability insurance makes sense for you? We prefer the disability rider or contract known as “own-occ,” which basically means that coverage will be afforded to you in the event that you are unable to perform your occupation. The reason for this is that in the event that you can no longer perform the tasks of your job, but you are possibly able to perform another job then you could still receive coverage under your policy.

Next up – Life Insurance: The standard coverage amount is 10-times your income. There are obviously some variables that come into play when calculating the amount of insurance needed. If there are mortgages or educational needs, it may make sense to add on those expected cost to your coverage. This way if something were to happen, the insurance payout would be great enough to pay off the house or put the kids through school. Also, in the case of a single income family additional insurance makes sense as well as adding insurance for future children.

What type of policy makes the most sense for your situation? We typically prefer term, but there are cases that permanent insurance makes sense. With term you can set the duration of your coverage, which may be until the kids get out of the house, or when you actually get the house paid off. If there are estate liquidity needs, especially for high net worth individuals or those who have a high level of very illiquid assets, permanent insurance may be a good option to look into. But wait, there’s more (insert infomercial voice-over)! Coverage for nonworking spouse does make sense, especially if there are children in the household. There is definitely a monetary value of stay-at-home parents that needs to be considered in this situation. The working spouse in most cases will need that cash flow to cover the mourning period as well as child care coverage expenses.

Brian and Bo briefly discuss umbrella coverage. It almost always makes sense to have some sort of coverage. It pays above and beyond the current limits of your other insurance policies. It can help protect your future income streams as well as lawsuits that exceed your regular insurance amounts. It is too easy not to have coverage, as it is normally very affordable, even for a fairly high amount of coverage.

An insurance topic would not be complete without touching on long-term care coverage. Here is what we know: The coverage area for this insurance need is a doughnut hole. If you have assets under $1 million, coverage probably is not appropriate, because the coverage is expensive and Medicare could help in your situation. For those that fall within the $1-3 million range, LTC coverage is probably most appropriate in your case. Medicare may not offer enough coverage and you could quickly deplete your assets trying to cover your expenses. The other side of the doughnut hole is those that have net worth in excess of $3 million. At this level it probably does not make as much sense to carry the coverage due to the high cost, and the availability of resources to provide self–management in this department.