Using Target Date Index Funds to Build Wealth

When you're just starting out, and you're wondering where to invest your hard-earned cash, what do you do? Individual stocks? Mutual funds? Index ETFs? 

It can be overwhelming, I know.

In this episode, we're going to simplify your decision-making process and introduce you to a safe and effective way to build wealth - target date index funds.

I’m going to walk you through what target date index funds are, how they're used, why they're important, and when you should use them. You won't want to miss this!

If you're looking to simplify your investment strategy and build wealth in a safe way, target date index funds are the way to go. Join me in this episode to learn all about them and take control of your financial future.

IN TODAY’S EPISODE, I DISCUSS: 

• Understanding risk profiles and their impact on investing
• The drawbacks of investing in individual stocks
• The benefits of target date index funds

RECOMMENDED EPISODES FOR YOU 
If you liked this episode, you'll love these ones:

• Demystifying Your Credit Score & Does It Matter
• How to Invest in ETFs & Index Fund to Create Wealth
• My Favorite Investing Accounts (And How to Maximize Your Returns)
• How the Top 1% Earners Accelerate Their Wealth (It's Not By Getting a Raise)

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Affluent Entrepreneurs Private Facebook Group https://www.melabraham.com/group/

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Transcript

1:56

One of the most often asked questions. I get is, hey, Mel, when you're first starting out, what do you do? Or they sit back and say, I. Don'T know how to invest. Do I do it in individual stocks? Do I do it in mutual funds? Do I do it in index ETFs. I don't even know what index and ETFs are. They say all those questions. We're going to answer some of those questions in this episode because I want to talk about out one way to invest which is going to simplify your decision making process, is going to simplify the amount of decisions you need to make to get you in the game and get you staying in the game in a safe way that gives you access to a diversified portfolio based upon your risk profile based upon your circumstances versus trying to pick and choose and analyze on your own. So we're going to talk about something. Called target date index funds. In this episode. We're going to walk you through what. They are, how they're used, why they're. Important, and when they should be used. All right, I will see you in the episode. Welcome to this episode of the Aflune entrepreneur show. Let's go have some fun. All right, welcome to this episode of the Aflun Entrepreneur Show. This one's going to be fun. We're going to talk about this whole idea of target date index funds. I know that I've done episodes on index funds and ETFs and things like. That in the past, but this is. A special version of index funds called target date index funds. And people will say, what are they? Well, I'm going to explain all of that to you. I'm going to walk you through the different things. And we'll jump to the iPad here in a moment. But here's the thing. One of the things to think about. Is this, is that when we talk. About investing, we are talking about what are we going to get back from the investment? That's the return part of the investment. But in order to get the return. We have to put something out. We have to put something at risk. We got to make the investment. We buy a stock, we're putting something out there. We're putting the amount of money that we put in the stock at risk. In order to get the return. And the challenge is that if we. Take on too much risk, we might lose a lot of money. So we got to be really careful. And so the idea this goes back. To the whole idea of your risk. Profile, which is your emotional ability to sustain a loss. It's psychology, it's emotional, it's all of that. That's risk tolerance, risk capacity is your financial ability to sustain a loss. And risk need is the return that you need to take on and the risk you need to take on to achieve your goals. And there's this balance, this delicate balance between all three of them, and it's different for everyone. But the question then becomes, well, once we understand our risk tolerance, capacity and need, and I did an episode on that very thing. But once we understand that, how do we invest? Now, you can invest in single stocks or you can invest in funds. Funds, which is a basket of stocks, ETF, which is an exchange traded fund, or an index fund, which follows an index. Those are things that we do. A mutual fund, although mutual funds have some expenses. I want to talk about all of that. Let me jump to the iPad where I'll give you an illustration of what that is so you understand what we're doing. So the one way that we used to only be able to invest is to buy individual stock investments. Okay? In other words, I buy specific companies. For instance, things like Exxon or Microsoft or Apple or Boeing or Walmart. And you can still do that today, and I do that and others do that. Here's the challenge is that when you buy an individual stock in a company, you actually are taking on more risk and you need more money in order to diversify. Here's what I mean by that, is that if I am going to build. A portfolio that's a diversified portfolio, I need to have a bunch of stocks in it. And if Tesla is right now trading. At $240 a share, and Adobe is trading at $400 a share, and Microsoft. Is trading at $300 a share, how. Many shares can you buy and be effective at diversifying your portfolio? So it costs more money to try and build a portfolio on individual stocks on your own. Okay, but here's the bigger issue. If you put all your money into. A single stock, a single stock can go to zero. But the stock market, God forbid, won't let me say that again. A single stock can go to zero, but the stock market won't. In order for the stock market to. Go to zero, all companies would have. To go belly up. They'd all have to go bankrupt, okay? Which is not going to happen. If that happens, we got bigger problems in our country. But the challenge is this, is that if you invest in a single company, for instance, there was a time where Facebook was trading at $300 a share and they released their earnings and it. Tanked by almost 50%. And if you had all your holdings in Facebook at that time, because that's what you were invested in, you lost half of everything. Look at Silicon Valley bank. Those people that invested in it, if it was the majority of their portfolio. They lost it all. So the problem with individual stock investing and why we don't recommend it as part of the Affluence blueprint at the very beginning, is because you take on too much risk. The volatility in a single stock is too high. I remember I do shakes every morning. I do my protein shakes with different kinds of powders and concoction for my health and my vitality and to keep going. And one of the things that I. Do is I put a whole lemon. In every shake and I'd buy the bag of lemons. And so I'll buy two pounds of lemons at a time and we'll put them in a bowl and all of that. But inevitably, if I don't use the. Lemons fast enough, one lemon goes bad, one lemon will go bad. It'll get moldy or soft or something. We have to throw it out. Now that's what can happen with a stock is one stock can go bad. But in a portfolio of stocks, if a single stock goes bad, you still have the other one. So when I throw that lemon out. I still have the other lemons in. The bowl that are still good, that I can use. Okay? So why we do this is to. Sit back and say, okay, I can. Buy individual stocks, but I take on. Much more risk and it's going to cost me more. So the other way to invest is to do it in what we call funds. It can be either a mutual fund, an index fund, or an exchange traded. Fund, an ETF, okay? Now what they do is they create. This basket and they buy the stocks. So the apples, the exxons and all of that stuff will be sitting in this basket. And what you invest in is the basket itself. Okay? So if you had $1,000 to invest. And Microsoft is at $300 and Apple is at $250 and Tesla is at. $250, you're only going to get like one or two shares of it. But if you have $1,000 to invest, you'll buy $1,000 of this fund that holds Tesla, Disney, Exxon, and you get. Little pieces of all of them. And if one of them goes bad like the lemon, it just gets taken out. Sorry, Disney, it just gets taken out. And the rest of it keeps going. So it's less money to get in and get a diversified portfolio and it reduces your risk to get in. So this is why we typically will invest in an index fund or an ETF. It's one of the things that I will tell people do right from the get go, is to start out, because what we want to do is at the beginning, we want to get in the game of investing, and we want to get in the game in a safe way. And the way to do that is through index funds and ETFs mutual funds. You can do it, but mutual funds are more expensive. There's a lot more fees involved with it because of the active management. And what statistics have shown is active managers actually don't outperform the market, okay? Not in the long term. They might do it in a year, two years maybe, three. But we're talking about over the long term they don't. So using ETFs and index funds is the most cost effective way to get into a diversified portfolio without a whole lot of work. Because here's what's going to happen. You no longer have to look at. The companies and evaluate the companies, look at financials. And I is Tesla a good company? Is Microsoft a good company? Is I don't know, Adobe a good company? If you're going to invest in an individual company, you've got to do some work. You got to do some analysis. You got to do all of that. Then you got to make the decision. Of how many shares? How much am I going to put in? How do I diversify? All that decision is made when you talk about the ETF or an index fund because they're creating a bucket, a basket of stocks that could be as much as 500 stocks, 2000 stocks. And if one goes bad, it doesn't hurt. Now I'm using the terms index funds. And ETFs kind of interchangeably. But they're different, okay? They're different. They both offer diversification, which we want. They both offer low costs, which we like. They both will have stronger long term returns because they track market indices and the market in the long term goes. Up eight out of ten years. Okay? The difference between an index fund and an ETF is an ETF trades like a stock. An index fund trades like a mutual fund. What does that mean, a mutual fund? When you buy a mutual fund, you don't get the mutual fund until the end of the day. So you might put the order in to buy the mutual fund in the morning when the mutual fund is at a certain price. But you don't get filled. The order doesn't get filled until the end of the day, until the day closes. So the value at the time you put it in may not be the value you get filled at at the end of the day. So index funds trade more like a mutual fund where they fulfill at the. End of the day. ETFs trade like a stock, meaning that. You put the order in and within. Minutes it typically exercises and you're filled, you're done. Okay? So you can trade throughout the day. Just like a stock. ETFs typically also have lower minimums. Some index funds require like $5,000 minimums to get in. ETFs typically have lower minimums. ETFs typically are more tax efficient. In other words, they're not doing a ton of taxes transactions that can trigger a tax. Okay? So that's the general element of index funds and ETFs. The question then though is what about target date funds? What is a target date fund? Okay, what's the difference? Here's the difference. It is a type of index fund. It's an index fund, but it's a type of it that has a little bit of management to it based upon a date. What you're doing is you're buying into a fund based upon when you're going to need the money. Because as we look at this and. I'll just jump to the iPad again. As you look at this, if you're young, say you're 20 years old versus 60 years old, the level of risk. You can take is far. Greater at 20 years old than 60 years old because you have much more time for it to recover if you. Have a down market. But at 60 years old, we don't want to take on that risk. So what that requires you to do is, as an investor, what that typically would require you to do is something we call rebalancing. In other words, and we do this. With a pension plan that it's like a $50 million pension plan that I help administer that we run the investments on. And so what ends up happening is that as you get closer to needing the money, the portfolio, the mix of the portfolio gets more and more conservative. So if you did that on your. Own and created your portfolio, you would have to look at the portfolio on a regular basis and decide, do I rebalance? Do I need to change the mix? Do I have to sell some of the funds, buy different funds and make it and adjust it based on your current risk tolerance, your current circumstances, your current proximity to the date that you're. Going to need it. What a target date index fund does is it actually rebalances. It automatically based on age. So as it starts off with a. More aggressive portfolio and as you get. Closer to needing the money, it reduces. And gets more and more conservative without you ever touching it. Okay? It's what they call a glide path. For the investment. And so what it does and the. Glide path looks a little bit looks like this. Okay? It starts out and say you're 45 years away from needing the money. You will have an allocation that has. A lot of US. Stocks, a lot of equities. So in this case it's, I don't. Know, 70% equity, 75%. Some of them are going to be even higher. And so your portfolio here is mostly equities right here at the very beginning. And we have a little bit of bonds. But as you notice, as we start. To move closer towards the retirement date. Which is here, the target date, then we start to reduce the risk by. Taking on more bonds and less equities. And then we maintain it here where we might even have treasury inflation protected bonds here. So what ends up happening is that. When we get into the years that are after our target date where we need the money, we have a very conservative portfolio. And so the way a target date. Fund works is you pick the date. You simply pick the date that you are going to go into the fund. Okay, that you're going to need the fund. You're going to go into the fund and start cashing in. So if I'm 30 years away from retiring, you'll pick a date that we're doing this in 2023. So you might pick a 2055 fund. So you pick a 2055 fund. And now the fund itself, the index. Fund, knows that you don't need the. Money for 30 years, so they can. Invest it more aggressively to get you. As much of a return as possible. Because they know that eight out of ten years the market goes up. And then now you'll see it then. Slowly reduce as you start eating at that 30 years, you get closer and closer to 2055 and all of a sudden you have the majority in bonds and not in stocks. Less aggressive, more conservative, less risk. And now you are in a situation where you don't have to do the balancing. The rebalancing is done by the fund itself. And so this is one of the easiest ways to get started because there. Isn'T a lot of thought. There's simply what's the date that I'm. Going to need the money? What's the fund I want to go. Into with that date and allow them. To do the rebalancing for you. Now, I recommend this, I can't recommend it directly for you because I don't know your circumstances. So this is not a recommendation or financial advice. But I usually will tell people when starting out, look at target date index funds because it takes the decision friction. Out of your investing game. And what I mean by decision friction. Is that the more decisions you have to make, the more difficult it is. For you to make the investment. We want to remove as much friction from investing as possible. We want our ability to get into investing as easy as possible because the. Sooner we get in, the sooner we. Eat up the wealth flatline, which I've talked about before, and we get into. That wealth acceleration zone. But if we are confused because we don't understand the choices we need to make, I don't know how to look. At different funds and how do I put the portfolio together or we're not. Sure which one to go into, then. What ends up happening is that decision. Friction gets us to do nothing. And doing nothing is a decision, but. It'S the wrong decision. All right? In my opinion, we need to be actively in the game to move ourselves closer towards that path to financial freedom. And so what I will typically have. People do at the very beginning, until they have critical mass in their portfolio. Is just start with a target date fund. Pick the date, pick the fund, get. In the game, stay in the game. And as it grows and as you grow and as you continue to do. This, you'll have the opportunity to change it out and go into a different. Type of portfolio where you're creating your own. And you're saying, I want this fund, this index fund, this ETF, and just doing it yourself like I do. But at the beginning, make it easy in the beginning, eliminate friction in the beginning, make it automatic. Actually, all throughout it should be automatic. Okay. And work it from that perspective. Now, are there issues with index funds? Absolutely. I mean, target data index funds. Absolutely. There are issues. Sometimes they have higher expense ratios and higher expenses because there is a little bit of active management because of the. Fact that they have to rebalance the portfolio. The second issue with them is that they only consider the date as a factor in when you need the money. They don't consider how long you need the money to last after that date. So if I pick 2055, they only consider the 2055 date. They don't consider that maybe 2055 is when you're 40 years old instead of 60 years old and that you need the money to last longer. So that's another issue. The other issue is that it does allow you to not think about it. A lot and the possibilities you absolutely. Forget about it, and you forget about. Really looking at it and saying, does it make sense anymore? Should I change it? Should I adjust it? And the other thing to think about is that when your life changes, this might need to change. And that happens with all your investment. Whether you maybe all of a sudden there's a health issue or you get married or you have kids, grandkids, you might want to shift your portfolio slightly. So a target date fund may need to be rethought on a regular basis. All of your investing, quite frankly, should. Be reviewed on at least an annual basis. Are the investments right for your current circumstances and your current vision? We're not looking at it in moments. But we're looking at it long term. To make sure that we take care. Of things and know that we're doing. The right things that allow us to. Flourish in the process. This is what target date index funds are. It's an easy way to get in the investing game. It's an easy way to get something that is a portfolio that will be. For the most part, in tune to what you need from a risk standpoint, given the time in which you're going. To need the money. It's a portfolio that's going to rebalance over time without you thinking about it. And it's a portfolio that you can. Adjust out of at some point when. You have critical mass in your investments. It's also a portfolio that you can. Buy outright in a brokerage fund that. You have, or in many cases you will have, these target date funds as options in your 401K plans or in your IRAs, and you can do them under Roth and or regular investments that way. So it's a great way to get in. It's a great way to eliminate the friction of decision making. It's a great way to start on. The path to financial freedom and get you moving forward. I hope that you found this of value and that you start to look at things a little differently and say, how do we remove the friction? How do we do the things that allow you to get in the game sooner, stay in the game longer, and reap the benefits of doing that? All right. I hope that this serves you. I hope that I get a chance to see you on the road, see you on another episode of the Affluent Entrepreneur Show. And as I always say, always, always. Strive to live a life that outlives you. See you soon. 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 face but group now by going to Melabraham.com/group and I'll see you there.