The Best (and Easiest) Investment for an IRA

Key Takeaways

• Target-date funds are an easy remedy for IRA analysis paralysis, when people know that they should get their IRA funds invested but aren’t sure where to put them.
• Challenging the assertions that target-date funds don’t add up for a lot of people.
• Which investors should avoid target-date funds in an IRA?

Susan Dziubinski: Hi, I’m Susan Dziubinski from Morningstar. This is the season when investors often rush in their last-minute IRA contributions. Joining me to discuss her favorite simple way for investors to get those funds invested is Christine Benz. Christine is Morningstar’s director of personal finance and retirement planning. Good to see you today, Christine.

Christine Benz: Hi, Susan. Good to see you.

Avoiding IRA Fund Analysis Paralysis

Dziubinski: Data suggests that people sometimes wait to that very last minute to make their IRA contributions, and then they may also procrastinate to get those funds invested into something other than cash. Why do you think investors often delay moving those funds into an investment? And why do you think that’s a potential problem?

Benz: We were just talking to some folks at Vanguard about this issue. They definitely observed this pattern where investors do rush in those contributions right before the tax-filing deadline. And in addition, they do oftentimes let the funds sit in cash after they’ve made those contributions. I think it’s mainly inertia would be probably the biggest force, but there could also be some analysis paralysis in there that people know that they should get the funds invested, but they’re just not sure where to put the money. So, I think that’s the primary cause. And the reason that this can be a problem is that if you do this year after year, those are months, and then you know, if you’re a serial procrastinator, those are years, of lost opportunities for compounding. The main idea is ideally you would get your IRA contribution in there and invested as soon as possible, which is Jan. 1 of whatever calendar year is underway. So, for 2023 contributions, we’re all eligible to make those contributions at the beginning of this year.

Dziubinski: Christine, let’s talk a little bit about an easy remedy for what you call this IRA analysis paralysis. What do you recommend?

Benz: Well, target-date funds have become mainstays in company retirement plans. They’re typically the default if the participant doesn’t take any action, they’re often defaulted into an age-appropriate target-date fund. It’s my opinion that target-date funds should be popular beyond the borders of company retirement plans. They are perfectly effective IRA solutions. They’re great all-in-one solutions for people who are looking to get their IRA funds invested in an age-appropriate way.

Dziubinski: We sometimes hear the argument about target-date funds that they’re suboptimal choices, they’re high cost, they’re one size fits none. What do you make of these critiques?

Benz: Well, whenever I hear these critiques, frankly, Susan, I kind of look around and ask myself, “What’s the ulterior motive there?” Because I do think oftentimes people taking potshots at target-date funds are selling some alternative to target-date funds, whether it’s some sort of a managed-account service or customized investment advice. And there’s certainly a place for those products and services, but target-date funds have gotten so much better over the past couple of decades. Initially there were many target -ate funds that were hobbled with layers of fees. Oftentimes, funds had these additional administrative expenses tacked on above and beyond what the underlying investments were charging. Those have largely gone away, and simultaneously, we’ve seen fund flows go to very inexpensive target-date funds. We’ve seen the better ones get the funds. So, on a dollar-weighted basis, investors who have put money into target-date funds have selected really good low-cost products. I just don’t think that the assertions that target-date funds don’t add up for a lot of people really hold water.

Do Target-Date Funds Belong in an IRA?

Dziubinski: Christine, are there any types of target-date funds that you prefer or like best? And what should investors be looking for?

Benz: Well, when I’m writing to big groups of individual investors or talking to groups of individual investors I have to operate with the assumption that I’m not going to see them again necessarily. We’re not going to have an ongoing relationship, so I’m not necessarily going to be able to check up on their portfolios. So, I tend to favor the very low-maintenance, low-cost index-fund-centric target-date series and the reason is is that there’s very little that can go terribly wrong with these products. They’re very well diversified. They’re inherently very low-cost. I think they’re super solid options for people who are looking into target-date funds. And the good news is that most of the major providers, whether Vanguard or BlackRock or Fidelity or Schwab, field really good target-date series that are anchored in index funds. So, investors don’t have to look too far to find these kinds of options. In fact, that’s where the flows are going in the series exactly like these.

Dziubinski: And then lastly, Christine, are there any types of investors who should avoid target-date funds in an IRA?

Benz: Well, a couple of categories. I tend to be less enthusiastic about target-date funds for people who are approaching or in retirement. I think typically people who are in retirement would want a little bit more control over their investment mix, and they’d also want more control over where they would pull their withdrawals from. So, if you’re taking a withdrawal from a target-date fund, you get a pro rata distribution of stocks and bonds in whatever proportion that they appear in the target-date fund. In retirement, that’s probably not what you want. You probably want the opportunity to pick and choose where you go for your cash if you’re in distribution mode. That’s one group that I would say would probably be better served with a more customized investment mix rather than a target-date fund. And then another group of investors who might look beyond target-date funds would be people who need to fill some roles, need to fill some positions in their portfolio with specific holdings. For example, if you’re accumulating most of your assets within your company retirement plan, but the bond funds aren’t great, well, you can use your IRA to fill out those missing areas of the bigger part of your portfolio. Some folks, may be better served by using their IRAs for more specific allocations versus using the target-date funds.

Dziubinski: Well, Christine, thanks for your time today and for these ideas for IRA procrastinators, we appreciate it.

Benz: Thank you so much, Susan.

Dziubinski: I’m Susan Dziubinski with Morningstar. Thanks for tuning in.

Watch “Should You Invest in Stocks, Bonds, or a 4% CD?” for more from Susan Dziubinski and Christine Benz.