Should You Invest in the S&P 500 or in a Target Date Index Fund?

March 17, 2023

Should you consider Target Date Funds instead of the S&P 500? In this highlight, Brian and Bo explain which one you should focus on and why.

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Let’s move on to Luke’s question. Considering that fund managers rarely beat the S&P over the course of 10 years, why should I consider Target date funds instead of the S&P? When people struggle to beat the S&P over time. Also, for reference, I’m 28. If that makes any difference on your response. Thanks again for all the insight.

Well, Brian, I think we ought to clarify something because, you’re right, Luke. There are Target date funds where they are actively managed, where there’s a manager that you’re paying a part of the expense ratio to go choose what to buy. If you listen to some of the nuances of what we say though when we talk about Target retirement funds, we say that we love for you to invest in Target retirement index funds. It is a slightly different version of a Target retirement fund where what they’re focusing on is, instead of individual security selection, they like underlying security selection. It’s focusing on broad asset allocation based on an acceptable risk level given and does a given a desired Glide path. So, if I want to retire in 2040, I’m going to go buy this set of index funds that will adjust accordingly between now and 2040 with an appropriate risk level for someone who might be retiring there.

We agree with you wholeheartedly. We love index funds, even when it comes to using Target retirement funds. Where you can do that, that use the Target retirement Index Fund. Yeah, I think a lot of people look at manager versus index funds. You know we love index funds. It’s the dirty little secret that most people who go with money are doing index funds because of that stat you shared about, you can’t beat the already-smart fund managers over the long term. Anyway, that’s what we’re doing with our money.

The problem with index fund, that box is already checked that leads to your step two of the questions of what you should do with your money. Is that what do you do about asset allocation? Because, look, yeah, you can go buy, and maybe in your 20s, a total market fund, a total market index or the S&P 500. That’s great. But when do you know when you need to start adding that element of diversification? There are a lot of people if you just set it and forget it, that as you build more and more success, it gets to be harder and harder. I like how the indexed target retirement funds also give a nod to the asset allocation because not only are they doing the S&P 500 or large-cap type indexes, they’re also doing small caps, they’re doing International indexes, they’re also doing Bond indexes. Look, for somebody in the 20s, go look at these things. Go to the biggest providers that offer these things like the Fidelity Investments, the Charles Schwabs, the Vanguards. Go look at their index Target retirement funds and look at the asset allocation.

This thing is not for your grandparents. I mean, as soon as you go put in when you think you want to retire, you’re like these guys, they’re lighting it up. I mean, they got some risk out there because that Glide path is going to be very aggressive in your 20s, but by the time you’re close to retirement, it’s going to be very conservative. Our goal is, hopefully, I’m just trying to take away as many distractions that keep you from how much you need to be saving and investing for yourself because this takes time on this journey of wealth building. And I don’t want people getting so caught up in the investment side where they, because remember, good investing is lazy investing where you set it, forget it, and create an automated wealth-building process.

I’m worried when everybody’s focusing on, ‘Hey, how much do I have in large cap? How much should I have in small cap? How much should I have in international?’ You’re wasting calories when your account has not even reached a critical mass where you’re getting the true value out of those components. Instead, you ought to be focusing on, ‘Hey, let’s set up the behavior, the automated wealth building. Now, how can I go increase my income? How can I cut my expenses so that I can put more money to work for me? I can put more money or more of my time into building memories and doing other things that actually have value.’ That’s why we have these types of rules.

I know a lot of people that say, ‘Okay, I’m just going to do the index thing, right?’ And I feel like this doesn’t always happen, but I was literally one of the guys that work out in the morning. He’s also in the financial industry, and we were he was like, ‘Hey, what do you think is going to happen this year?’ And I was like, ‘Well, you know, the S&P 500 is down 19% last year.’ And so I kind of went through some thoughts, and he goes, ‘Oh man, no, but I feel like all the clients I work with, man, they’ve got a bunch of, like, super tech-heavy stuff. Anybody’s got Tesla in their portfolios with index funds, you know, they’re down, like, 35%, 38%, and I feel like a lot of folks say, ‘I’m just gonna go buy a low-cost index funds. They’ll see, oh, S&P 500 was fine.’ But man, what if I went and bought XXX? It’s the same thing that you saw in the late ’90s, where if you were just buying the boring index and not, like, the tech-forward type indices, you were getting yourself in trouble. I like Target Retirement index funds because behaviorally, it can serve to protect you from yourself, and you can say, ‘You know what? They got the asset allocation. They’re figuring out the index funds. They’re doing that piece. I can focus on exactly what Brian said to focus on.’ Because I think we all fall prey to that. Yeah, I mean, and it keeps you. Because, by the way, you said 30 or 40 on Tesla in 2022. Look out below. I mean, it was much more than that. He was referencing tech funds that had Tesla in them specifically. But yeah, I’m with you.

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