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Target-Date Funds Are Out of Date

Betterment improves on the basic idea of "set it and forget it" target-date funds with smarter, unbiased advice and tax-smart tools.

Articles by Nick Holeman, CFP®
By Nick Holeman, CFP® Head of Financial Planning, Betterment Published Sep. 25, 2018
Published Sep. 25, 2018
4 min read
  • Target-date funds were revolutionary, but haven't advanced since their beginnings.

  • Betterment’s advice offers more exact, personalized, and tax-efficient advice than a target-date fund ever can.

Go back to 1994: The year brought us the first Playstation, Netscape Navigator, and target-date funds. While the Playstation is now on its fourth generation and Netscape is now extinct, target-date funds now make up over $790 billion of retirement assets.

Even though target-date funds are popular, are they still the best option for your retirement? Maybe back in 1994 they were. Especially for employees who no longer had pensions to lean on but had little to no experience managing their own investments.

But since then, financial advice has progressed light years beyond using just one data point—your desired age of retirement—to determine your investment plan.

At Betterment, we’ve improved on the basic idea of “set it and forget it” investing. Our smarter technology has allowed us to offer retirement advice that is both low cost and personalized.

Target-date funds can’t do that.

Here are six ways Betterment’s advice beats a target-date fund.

1. Exact Years, Not Target Dates

You may have noticed target-date funds only come in five-year increments. You can choose the 2045 Fund, 2050 Fund, 2055 Fund, etc. But what if you don’t want to retire in those exact years? At Betterment, our advice can be tailored to the exact year you want to retire. You no longer have to choose the fund that is “close enough” to your desired retirement date.

2. Personalized Advice

Target-date funds try to paint a detailed picture using a very broad brush. They assume that every person who retires in blocks of five years has the same life expectancy and the same risk tolerance. With a target-date fund, you’re stuck with what you get.

At Betterment, our retirement advice adapts to your life expectancy and can be customized if you are a more conservative or aggressive investor.

3. Smarter Advice

The fastest car won’t win you the race if you forget to fill up the gas tank. And the best investments won’t help you retire if you don’t save enough. Target-date funds ignore how much you have saved, which is the single most important part of a successful retirement.

At Betterment, we tell you if you are on or off track, factoring in all of your retirement savings, Social Security, pensions and more. We also tell you in which accounts you should invest, to maximize growth and reduce taxes. Should you invest in a 401(k) or IRA? Roth or traditional IRA or 401(k)? The answer depends on a lot more than just your target retirement date. We’ll help you each step of the way.

4. Unbiased Advice

A basketball game wouldn’t be very fair if the referees were paid for by one of the teams. That’s how target-date funds operate. You can’t blame them for being biased, but your retirement needs an unbiased fiduciary to help you make the best decisions.

When you look under the hood of a Vanguard target-date fund, you will only see Vanguard investments; Fidelity target-date fund, Fidelity investments. The same goes for any target-date fund out there.

At Betterment, we don’t offer our own investment products. Instead, our automated advice engine and portfolio selection are guided by a human team of experts on our investment committee. They are free to select the best investments we can find, regardless of who makes them. No single company is the best at every type of investments, so don’t limit your retirement to just one company’s investments.

5. Tax Loss Harvesting+

Tax loss harvesting is a powerful tool that can reduce your taxes and increase your investment returns by up to 0.77%. However, the IRS has strict rules you must follow to execute this strategy properly.

Betterment offers tax loss harvesting to all our customers, and we monitor your taxable and retirement accounts to make sure you don’t violate wash sale rules. Even if target-date fund providers provide tax loss harvesting, they leave the burden of coordinating their retirement accounts to their customers.

6. Tax-Coordinated Portfolio™

With a target-date fund, your stock and bond allocation is the same, no matter in which types of investment accounts you hold those funds. However, not all accounts are taxed the same, and how you locate them can matter a lot in the long run.
IRA account withdrawals are subject to ordinary income taxes, taxable account withdrawals are subject to capitals gains taxes, and Roth account withdrawals are tax-free.

Smart investors can use these differences in taxation to optimize which investments are held in which accounts. High growth assets (such as funds that follow emerging markets) should be held in a Roth account, and tax-efficient assets (such as funds invested in municipal bonds) belong in a taxable account.

At Betterment, when you take advantage of turning on a Tax Coordinated Portfolio™, we’ll manage the location of each asset automatically for you to reduce tax drag and increase your after-tax returns.

Wrapping It All Up

The Playstation console and Netscape Navigator were both great in the 90’s. But technology has moved on, and so has retirement advice. It is now possible to give low cost advice that is more detailed, more tax-efficient and more personalized than a simple target-date fund.
We clamor for the advancement of products all the time — electronics, search engines, medicine. Betterment is here to provide the same for your retirement.

With contributions by Katherine Buck. 

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