After a raging bull market, capital preservation may be in order. After all, the last thing you want to do is give up all of your gains and then some. If you do, that would be like wasting a whole bunch of time and emotional capital.

Since I started investing in 1995, I’ve round-tripped many individual investments. As a result, most of my equity capital has been invested in passive index ETFs. You might get lucky buying a stock with great gains. But you’ve got to get lucky twice by knowing when to sell the stock as well.

For example, soon after I had bought Life Time Fitness Group, the stock zoomed up 40% within 30 days. Once the omicron news came out, the stock came all the way back down to my original purchase price. As the stock collapsed, all I could think about was what a waste of time it was researching and writing my article.

Let’s discuss capital preservation and our desire to protect our money.

After sharing my 2022 housing market forecast, it’s only right to share my 2022 stock market forecast. Creating forecasts helps me think things through given I’ve got real money at stake.

First some background.

Due to continued gains in the stock market, roughly 35% of my net worth is in equities. This is 5% higher than my upper-limit target of 30% as I’ve let positions ride. 50% of my net worth is in real estate after buying a new home in 2020.

70% of my equity investments are in index funds. The remaining 30% of my equity investments are in single stock names such as Apple, Tesla, Google, Meta, Amazon, and Netflix. I’ve held these growth stocks for years; as a result, their percentage has grown from about 10%, 10 years ago.

The most recent high conviction post I published was on March 18, 2020, How To Predict A Stock Market Bottom Like Nostradamus. I ended up dumping about $300,000 in the S&P 500 and various stocks in March and April 2020. Unfortunately, I did not hold onto my entire position all the way up. But I have held onto 95% of my existing positions.

Overall, my stocks generate between $1,600 – $1,800 in dividend income a month. The dividend income could be 7-8X higher, but I predominantly invest in growth stocks over dividend/value stocks. When I’m in my 60s with likely lower income, I will allocate more towards dividend stocks.

In 2021, my public investment portfolios (includes bonds) grew 24.5%, underperforming the S&P 500 by about 2.5%. In 2020, my public investment portfolios grew 40%, outperforming the S&P 500 by about 23%.

Finally, I worked in equities for 13 years and have been investing in stocks since 1995. Now that I’ve shared some details, here is my 2022 stock market forecast.

Some people think sugary processed foods are why we get soft. Other people argue transitioning from a labor-intensive to a capital-intense economy makes us less active. I’m going to argue high I Bond returns are the real reason for making us not try so hard!

Investing in an I Bond today is almost too good to be true. How amazing is it that we can borrow at a negative real rate, yet earn a positive real guaranteed rate? This is an anomaly that won’t last forever. Take advantage.

Every person can buy $10,000 worth of I bonds with a 9.62% interest rate starting in May 2022! This is up from 7.12% at the beginning of 2022. After six months, the interest rate will float, depending on inflation. But with inflation elevated, you might as well take advantage.

If you’re married, you can buy $20,000 worth of I bonds in December and buy another $20,000 of I bonds in January the following year. If you each own a business or trust, now you’ve got four entities able to buy $10,000 worth of I bonds each year. In other words, your combined unit could purchase $80,000 worth of I Bonds in a short period of time.

Just know I bonds can’t be redeemed for one year. You can cash them after one year. But if you cash them before five years, you lose the previous three months of interest. 

I would invest ~80% of my net worth for a guaranteed 9.62% return if I had the option. After such a massive run-up in risk assets, locking in a guaranteed 9.62% return feels nice!

Therefore, at the very least, I’m going to be buying the maximum amount of I bonds this year and next. You can check TreasuryDirect for more I Bond info.

The new COVID variant, Omicron (B.1.529) was first detected in South Africa in November 2021. Omicron is now the dominant COVID variant today.

Reports are showing Omicron is less potent, which is leading to less hospitalizations per infected cases. Reported symptoms are generally more mild as the variant doesn’t seem to attack the respiratory system as hard. However, it also seems as if Omicron is more contagious than previous variants.

Given we went through the Delta variant without too many hiccups, the investment thesis for this latest variant should hopefully be similar. Let’s review this latest COVID variant investment thesis for stocks and real estate.

I made a mistake with both my children’s 529 plans. Instead of investing in equity index ETFs, I invested in target date funds (TDF). Both target date funds have significantly underperformed, costing my children $30,000+ of lost profits in just a few short years.

A target date fund – also known as a lifecycle, dynamic-risk or age-based fund – is often a mutual fund designed to provide a simple investment solution through a portfolio whose asset allocation mix becomes more conservative as the target date approaches. The target date is usually retirement, but can be for any upcoming expenses such as college tuition.

Target-date funds offer a lifelong managed investment strategy that should remain appropriate to an investor’s risk profile even if left unreviewed. The strategic asset allocation model over time is known as the glidepath.

Let me share why investing in target-date funds in a 529 plan or retirement plan may not be the optimal move. I’ll share why I made the mistake and what I plan to do about it.

Superfunding With A Target Date Fund

When our son was born in April 2017, I decided to superfund his 529 plan by the end of that year. In retrospect, I should have opened up his 529 plan in 2016 and then changed beneficiaries when he was born. However, better late than never.

By mid-2018, my wife also superfunded our son’s 529 plan. We had now contributed $150,000 between us and couldn’t contribute more for the next five years. As first-time parents, we wanted to get the college savings aspect out of the way so we could focus on being good parents.

Since 2017, my dear mother also generously contributed $66,500 to our son’s 529 plan as well. With a total of $206,500 in contributions through 2021, you would think the 529 balance would be well over $300,000. After all, the S&P 500 is up about 70% since mid-2018.

Unfortunately, that’s not the case. Due to investing in a target date fund instead of a S&P 500 ETF, our son’s balance was only $299,640.29 through October 2021. The dark line below shows the balance. The light blue line shows the contributions since July 2017. The difference is the profit, which stood at $93,140.29.

If I had invested in an S&P 500 index ETF instead, our son’s 529 balance would be about $30,000 higher to ~$330,000. $30,000 could easily pay for one year of public university tuition. Damn.

Target Date Fund Severely Underperforms In A Bull Market

Below are the returns by period. The fund’s 3-year return is only 14.55% versus a 21.48% 3-year return for the S&P 500. What’s worse is that the YTD performance through October 2021 was only 10.85% versus 24.04% for the S&P 500 index.

Of course, target-date funds should underperform the S&P 500 in an equity bull market. After all, a TDF is a mix between equity and fixed income. To be fair, target-date funds should be compared to more balanced funds, such as 60/40 funds. However, I did not anticipate such tremendous underperformance so early on.

The NH Portfolio 2033 TDF I invested in has roughly a 30% weighting in bonds, 38% weighting in U.S. equities, and a 32% weighting in non-U.S. equities. The bonds and non-U.S. equities have really dragged down the performance.

I’m not sure what non-U.S. equities the fund invested in, but the U.S. has been one of the best-performing countries in the world since the pandemic began.

What Else Went Wrong? Being Too Conservative To Start

In 2017, when I was deciding between target-date funds in the 529 plan, Fidelity suggested I invest in the NH Portfolio 2035 fund. 2035 is the year our son turns 18 and potentially goes to college.

However, back in 2017, the real estate market and the stock market were feeling frothy. I was also in protection mode as a new father. I traded in my Honda Fit for a safer SUV, sold my main rental property to buy back more time, and became slightly more conservative with my equity weighting. Instead of taking more risk, I focused more on capital preservation after a nice recovery since 2009.

As a result, I invested in the NH Portfolio 2033 fund, which assumed our son would go to college in 2033. As a result, the fund had a greater weighting in bonds than the 2055 fund. The difference in percentage points was ten percentage points if I recall correctly, e.g. 80/20 vs. 90/10 to start.

S&P 500 Historical Returns

It turns out, being conservative paid off in 2018. The S&P 500 finally had a down year, -4.38% after the following huge years:

2009: +26.46%

2010: +15.06%

2011: +2.11%

2012: +16%

2013: +32.39%

2014: +13.69%

2015: +1.38%

2016: +11.96%

2017: +21.83%

2018: -6.24%

2019: +28.88%

2020: +16.26%

2021: +27%

Put yourself in my shoes. Would you have dared invest $75,000 after such a long winning streak? Further, 2017 was one of the hottest years for the stock market. It felt risky to dump $75,000 in July 2017, so I didn’t.

Instead, I contributed $15,000 to start and then just kept on contributing more as the year went on. In the end, I decided that since I had an 18-year investing time horizon, I might as well superfund.

To feel better about investing so much after such a large run, I was more conservative with my asset allocation. It was a fair compromise at the time.

Did Not Adapt After 2018’s Decline

After a disappointing 2018, I decided to leave the funds in the NH Portfolio 2033 TDF. My wife was in the process of superfunding in 2018, which felt appropriate. Our decision was for me to superfund in 2017 and for her to space out the contributions to hedge against a market downturn.

In retrospect, if we had a crystal ball, we would have invested 100% in an S&P 500 index at the end of 2018. Here’s what happened in the S&P 500 after:

2019: +31.49%

2020: +18.4%

2021: +25%+ so far

At Fidelity, you can rebalance your 529 plan twice a year. Check your plan’s rebalancing limit a year. Here is my 2022 stock market forecast if you’re interested. If it comes true, investing in a target date fund will probably be good. So far, having a more conservative asset allocation is working out.

Target-Date Funds Asset Allocate In The Opposite Direction

Not only did we not change our asset allocation to more equities after a negative 2018, due to the nature of target-date funds, our equity allocation declined even further!

The idea of a TDF is to continuously increase the fund’s allocation towards bonds each year as one gets closer to the target date of college or retirement. This makes sense. However, the biggest drawback is that the fund does not change at all based on equity or bond performance.

For example, if the S&P 500 goes down 35% one year, I will be rebalancing more towards equities and away from bonds. I did so in March 2020 when I wrote, How To Predict A Stock Market Bottom Like Nostradamus.

However, target-date funds will just operate like zombies based on a set target date with preset allocation weightings. The automation of these types of funds makes me wonder why there is even a fund manager getting paid to run these funds at all!

Target Date Fund Fees Are Relatively High

Not only has my TDF significantly underperformed the S&P 500, it also has an expense ratio of 0.87%. In comparison, the expense ratio of the Vanguard Total Stock Market ETF (VTI) is only 0.09%.

Over a five-year period, I will have paid about 4% more in fees. And over an 18-year period, I will have paid 13.86 percentage points more in fees. Those fees may amount to tens of thousands of dollars that could be used for education.

Imagine your 529 plan growing to $500,000 when your child is 18. $500,000 X 0.87% = $4,350 a year in annual fees. Instead, you could have paid $450 a year in fees by holding index ETFs. What a waste, given by then, the target date fund will likely have a very conservative weighting and hence, a lower return.

Active Versus Index Target Date Funds (A-Hah Moment!)

After comparing my daughter’s target date fund to my son’s target date fund, I realized I had picked an “actively run” target date fund for my son and not an index target date fund. My daughter’s target date fund says (Fidelity Index) next to it and only has a 0.14% expense ratio.

I now remember the Fidelity rep in 2017 telling me the two choices on the phone. He sold me on the actively run target date fund without mentioning the higher fees. I was under the assumption the fees were the same. If I knew the fee difference was so large, I would have certainly gone the index route instead. But I was probably sleep-deprived and not thinking straight back then.

Therefore, before investing in any fund, please always ask about its expense ratio! Don’t just assume you will be investing in an index TDF with lower fees.

It’s amazing how it’s taken me writing this post to realize the type of target date fund I invested in for my son. I wonder how many other unsuspecting investors don’t realize this as well.

No Wonder Why Target-Date Funds Were Created

Target-date funds are an amazing money-maker for the firms that create them.

Over time, target fund creators make more from their clients as balances grow. Meanwhile, the fund managers don’t have to generate any alpha for charging high fees. Instead, the clients are OK with declining returns, making it even easier for the fund manager to do their jobs!

How cool is it to be rewarded for consistently underperforming your respective indices? Because busy parents have so much going on, they often don’t bother to do a deep-dive analysis of their returns. Parents end up “setting it and forgetting it,” which is music to a target fund manager’s ears.

For the first three years of our son’s life, we worried constantly about his vision and health. We also seldom had a good night’s sleep. Although I’m on the ball with regards to our investments, I wanted to forget about his 529 plan so I could focus on other things. That was the point of me investing in a target date fund in the first place.

But now that I’ve been able to slowly come up for air, I’m thoroughly disappointed in actively-run target-date funds and my decision to invest in them. Its lagging performance has been bugging me since 2020. However, I was hopeful that the fund would narrow its underperformance in 2021. Unfortunately, its underperformance widened.

Related: Recommended 529 Plan Amounts By Age

Choose A Index Target Date Fund Instead

With inflation and upcoming Fed rate hikes, having a 30% weighting in bonds seems like too much. Further, there are still 14 years left before our son potentially goes to college. As a result, our son’s 529 plan can afford to take on more risk.

Even if we keep the 70/30 equity/bonds allocation the same, I’ll just buy low-cost ETFs to recreate the allocation and save 0.78% a year in fees (0.87% – 0.09%). I’m unwilling to pay $2,300+ a year in fees for a actively run target date fund I can easily create myself. Or, I’ll just switch to an index target date fund with much lower fees. Check your 529 plan provider to see what’s possible. Fidelity only allows you to choose between active and index target date funds.

If you must own a target date fund, then own one during the first several years of your child’s life. That will be when the expense is most worth it. You’re busy and need all the help you can get. Further, you aren’t paying a high absolute dollar amount in fees because your balance is still low. Even if you lose a lot of money in a bear market, you won’t be too pissed either.

Three Years Or $100,000 Until You Create Your Own Fund

Three years after you child is born or a $100,000 balance, whichever comes first, creating your own target date fund with index ETFs is probably the more optimal way to go, if you can. You are a more experienced parent so you will be more relaxed. Further, you may also have more time because your child has started attending preschool or daycare.

If you create your index target date fund, you just need to be careful with your asset allocation. Every six months to a year, you should revisit your asset allocation to ensure it corresponds with your objectives.

The easiest thing to do is to follow the asset allocation path of a target date fund you could have invested in. Alternatively, you can asset allocate based on age or just stick to a fixed asset allocation.

If you can’t create your own fund with ETFs, then invest in an index target date fund with a lower fee. Again, my daughter’s index target date fund only has an expense ratio of 0.14%.

Love And Worry Is A Profitable Industry

The money management industry, like the higher education industry, smartly takes advantage of a parent’s love and worry for their children. Love and worry are why colleges can continuously hike tuition much faster than inflation. Worry and love are why active target-date funds can charge a high fee, when little investing acumen is required.

And let’s be fair here. If the S&P 500 would have continued to struggle after 2018, I would have felt relatively better about investing in a target date fund. The fund would have outperformed the S&P 500, which would have made paying an 0.87% expense ratio more palatable.

However, even still, I would have eventually woken up to the fact that I was paying more in fees than I had to. It was kind of like my epiphany when I ran my 401(k) through Personal Capital’s 401(k) fee analyzer. I realized I was paying $1,700 a year in fees I had no idea I was paying! The main culprit was also a Fidelity fund with a 0.74% expense ratio and 95% turnover ratio.

Paying a fee is absolutely fine for something you can’t do or don’t want to do on your own. But when it comes to a 529 plan or retirement with a long time horizon, we can all construct a simple two or three ETF portfolio and save.

Who Should Invest In Target-Date Funds?

Target-date funds can definitely help investors who want a simple and risk-appropriate way to invest over time. Having an automated glide path is assuring if it fits your objective. However, fees need to come down.

Here’s who I think target-date funds are appropriate for:

• First-time parents who want to get their 529 plan investing out of the way
• People who have no interest in staying on top of their investments every quarter, six-months, or year
• Busy professionals working in an industry other than finance and who have little knowledge about investing
• Investors OK with frequently not beating the S&P 500 index in exchange for less volatility

Again, if you do invest in a target date fund, invest in an index target date fund with lower fees. Outperforming a respective index over the long term is hard to do.

Related Post And Questions

How To Reduce 401(k) Fees Through Portfolio Analysis

Different Investment Strategies For Different Life Stages

Roth IRA or 529 Plan To Pay For College

Readers, anybody invest in target–date funds? If so, why? How do you get over paying a higher fee? Do you invest in target date funds for your children’s 529 plans or retirement?

Join 50,000+ others and subscribe to my free weekly newsletter. Since 2009, the newsletter has helped people achieve financial freedom sooner, rather than later. The Problem With Target Date Funds is an FS original post.

Before I share the best asset class performers from 2001 – 2020, I want you to guess the following four things:

1) Of the following asset classes, the S&P 500, a 60/40 stock/bond portfolio, Bonds, REITs, Commodity, Emerging Market Equity, Small Cap, Homes, which performed best?

2) What was the annualized return for the best-performing asset class within 0.5%?

3) What was the annualized return for the worst-performing asset class within 0.5%?

4) What was the annualized return for the average investor within 0.25%?

If you guessed two or more correctly, you are very much in tune with the market. Therefore, in terms of how to invest, you may want to increase the actively managed percentage of your overall investments.

If you only got one out of four right, then you’re probably inline with the average investor. And if you got zero right, then you should probably be a 100% passive index investor or let a robo-advisor manage your money for you. All you have to do is electronically send in a check each month and the robo-advisor will asset allocate for you.

Now that we’ve gone through this exercise, let’s compare the actual results to your estimates. When it comes to honing your forecasting abilities, reviewing data and analyzing why you were wrong is very important.

If we can consistently make decisions with a 70% positive probability, we will do very well in life. Waiting until we have 100% certainty is often impossible and unnecessary.