A Rant to Make You Rethink Target Date Funds – Episode 118

Have you looked into target date funds as an investment option? A lot of dentists are drawn to this seemingly safe, inexpensive, and low maintenance way to save for retirement. But there’s often a misunderstanding about why these funds exist and who should be using them. In this episode of Dentist Money™, Reese & Ryan explain the intent of target date funds, the limitations they impose for dentists, and how they often get misused.

Podcast Transcript

Reese Harper: Hey everybody, Reese Harper here and thanks for listening to the Dentist Money Show. In today’s episode, Ryan and I are going to talk about a really popular way that people like to invest their money called target date funds. We’re going to talk about what they’re intended for and what they’re definitely not intended for. We’ll talk about the pros and cons and the risks you might be taking if you’re using target date funds in your portfolio.
I’m excited to announce our new website is now up and running, so go to dentistadvisors.com and you’ll find a bunch of great educational resources. We’ve got an education library with podcasts, articles and videos on a variety of topics for dentists. So check that out and while you’re on the website you can book a free consultation with one of our advisors. We’ll talk to you about your situation and show you how you can take control of your future so you can start living in the moment right now. If it’s easier for you, you can also just give us a call at 833-DDS-PLAN.
I also wanted to let you know about a new and easy way for you to submit your financial questions for the Dentist Money Show. Just go to dentistadvisors.com/listen or if you’re at dentistadvisors.com you can just go to our podcast tab and click the button that says submit question to podcast. You’ll fill out a quick form and we’ll do our best to answer your question on an upcoming episode. Thanks again for listening and enjoy the show.

Speaker: Consult an advisor or conduct your own due diligence when making financial decisions. General principles discuss during this program do not constitute personal advice. This program is furnished by Dentist Advisors a registered investment advisor. This is Dentist Money. Now here’s your host, Reese Harper.

Reese Harper: Welcome to the Dentist Money Show where we help dentists make smart financial decisions. I’m your host Reese Harper here with my rocking cohost, Sir Ryan Isaac.

Ryan Isaac: Two nicknames in one day.

Reese Harper: I want to officially welcome you Ryan this morning.

Ryan Isaac: Thank you.

Reese Harper: After putting up with me for several years, you’ve been kind, supportive-

Ryan Isaac: It’s been 11.

Reese Harper: … and you’ve put up with my rants.

Ryan Isaac: Yeah have heard some good ones.

Reese Harper: And today is going to be one of those. Am on one. And am on the-

Ryan Isaac: It’s good content.

Reese Harper: … a rant about a subject that I think people really need to understand because they think that what they’re doing is savvy and smart. But what they’re really doing is ignorant and short sighted.

Ryan Isaac: Okay. Ouch.

Reese Harper: That may come across offensive to some or I hope that I don’t offend you too much, but I feel like this is something where there’s a lot of online chatter about this subject and in my experience it actually can be pretty detrimental. It’s one of those things where you think you’re doing something really smart and then you realize like 10 years later after you did it, you’re like, “Oh yeah, I didn’t really have all the information.”

Justin Copier: Like eating butter.

Reese Harper: Yeah like eating lots of butter or those Toll House Cookies that come from the yellow bag and you just bake them all at one night and eat them last night.

Ryan Isaac: What?

Justin Copier: That was very specific.

Reese Harper: Yeah. Oh, that was not me. I didn’t do that. And it wasn’t midnight.

Ryan Isaac: Seems very personal.

Reese Harper: That seemed too specific to be a joke.

Ryan Isaac: I feel those are really specific … you’ve seen. You looked really pained when you said it.

Reese Harper: So the subject of today is target date funds. Okay. The target date fund. I’d like you to kick this off though with a story that we’ve prepared for this very subject.

Ryan Isaac: Well, it just comes from one of the greatest movies of all time. I’m not going to give it away. I’ll set the scene. Okay. The scene in this, one of the greatest movies of all time, the scene is that there’s this villain guy, and throughout the whole movie he keeps using a word for various situations. Sometimes it seems like it applies, sometimes it doesn’t seem like it applies. And finally after a one of our heroes in the movie gets a little fed up with it, he turns to him and he says, “You keep using that word. I don’t think it means what you think it means.” What’s the movie? You know the movie.

Reese Harper: Princess Bride.

Ryan Isaac: You knew the movie who’s the guy who says it?

Reese Harper: Ernesto Montoya.

Ryan Isaac: Yeah. It’s Inigo.

Reese Harper: Yeah.

Ryan Isaac: Indigo, Indigo. What is it?

Reese Harper: Yeah Inigo.

Ryan Isaac: Indigo.

Reese Harper: It’s Inigo Montoya.

Ryan Isaac: Yeah.

Justin Copier: Ernesto did you say Ernesto?

Reese Harper: I think it was Ernesto.

Ryan Isaac: That’s his cousin. That’s his twin cousin in the movie.

Reese Harper: That’s his father I think.

Ryan Isaac: It’s his stunt double. Yeah. He turns to, who was the guy like Vicenzo or something? He keeps saying inconceivable. So there’s the guy who keeps saying inconceivable after everything that happens.

Reese Harper: Oh yeah.

Ryan Isaac: You know that.

Reese Harper: That’s the short dude.

Ryan Isaac: It’s like Vicenzo or something like that.

Reese Harper: It’s a really short guy that’s the dwarfy, bald character.

Ryan Isaac: Yeah. No offense about bald people.

Reese Harper: Sorry it wasn’t trying to offend you.

Ryan Isaac: Or short people jeez. So keeps saying inconceivable the whole time. And finally Montoya turns to him and he says, “You keep using that word. I don’t think it means what you think it means.” And it’s funny because we would say you keep using that fund I don’t think it does what you think it does. And that’s what we’re going to talk about today, is using target date funds in the appropriate way. What are they meant for? What were they designed for? And then how are people using them in ways that they probably shouldn’t be using them?

Reese Harper: Let’s jump right in and talk about why these funds were invented. What was the purpose of them?

Ryan Isaac: Yeah, so they were invented in the early 90s from a couple advisors at Wells Fargo and they weren’t that popular for a while until, it was like the mid-2000s, 06. There was some new legislation passed. So in retirement plans in like 401ks and things like that, there’s a provision they could set up a lot of times that is automatic enrollment and there’s some benefits if your plan has automatic enrollment subject for another day.
But the issue was that these employees were now being automatically enrolled and there wasn’t a suitable option for where their money automatically got put into. And so that’s where they really picked up steam. And so they were invented for simplicity we’ll describe what they are in a little bit, but they are invented to keep things really simple.
They were meant for people with very small balances and they became popular for people who just got automatically enrolled into plans at very small balances, weren’t paying attention to any of this stuff. And one of the big benefits over time was that they kept a good risk profile for people who literally didn’t look at their accounts for decades, which happens a lot.

Reese Harper: So most everyone in a 401k plan?

Ryan Isaac: Yeah. So they invented for these like small balance employees, to just have like one fund solutions to give them a fair amount of diversification to try to keep their risk in line with their age and their retirement date. That’s where the target date comes from.

Reese Harper: Let’s explain real quick what it actually is.

Ryan Isaac: So a target date fund is a fund that has a date that’s supposed to coincide with when you think you’re going to retire. So let’s say you think you’re going to retire in the year 2050. It’s a long time. Anyway, you think you’re going to retire in the year 2050. The way the fund works is it starts out, it’s just one fund inside the fund and we can break this down in a minute, but inside the fund there’s multiple funds. They’ll usually like are you-

Reese Harper: Stuff that’s going to grow and stuff that’s safe and they’ll mix it together in one fund.

Ryan Isaac: Yap. And so early on the fund is more aggressive. It’s more stocks and less bonds and less cash. And then every year as it goes by, they start adding more bonds and taking away stocks to make it more and more conservative so that by your target date, retirement it’s supposed to be very conservative and be more appropriate for your situation.
Again, this was invented to solve the problem of employees being automatically enrolled. And then they just forget about this stuff, they just wanted to have something that’s suitable for a person that doesn’t pay attention to this stuff in a small account and then know how be super aggressive when they want to take the money out in retirement.

Reese Harper: Yeah. And it actually serves a good purpose in that context because if you don’t know anything about investing money and you go to start investing and you look at all these options, sometimes it’s super overwhelming for people. It’s like what’s the small cap Dreyfus International research-

Ryan Isaac: You’re going back to Richard [crosstalk 00:08:45]

Reese Harper: Or it goes like in 401k plans, they’re really like marketing savvy names like the new world’s search fund, and you’re like, “Oh, that sounds like really cool. I going to put 10% in that one.”

Ryan Isaac: The search fund.

Reese Harper: Yeah. The high tech growth fund.

Ryan Isaac: Feels like an explorer.

Reese Harper: Yes. I of course I need a little high tech growth.

Ryan Isaac: Who doesn’t?

Reese Harper: The fund families has got to the point where they would use names that were attractive as opposed to descriptive. An investor like myself, when I’m looking at a 401k lineup, I want to know from the name of the fund what it’s objective is, what it’s targeting?

Ryan Isaac: S&P 500 Large Cap Growth.

Reese Harper: United States small capitalization value.

Ryan Isaac: Sounds boring.

Reese Harper: It’s easy to understand like what they’re talking about. If they describe them properly. But for many years, I mean the mutual funds were given labels that were really-

Ryan Isaac: We would call yours the mom and pop explosion fund.

Reese Harper: I would be like, “I like that sound.” Seems like a guy could trust down home and country. Keeps it real.

Ryan Isaac: Just a little store on the corner that’s about to take off and go public.

Reese Harper: Pop probably has a good insight into them markets. See that’s the view anyway. So you look at it and you get these names, you don’t really know what to buy. And so they came up with these target date funds. Partially to clarify for an investor, “Look, if you just don’t want to think about this too hard, it’s not going to be bad for you to just put your money in something that gives you good diversification and it slowly gets more conservative as you age.” And if you’re going to retire in 10 years, it’s a more conservative version than the one that’s way out there. You’ll see a 2020 fund, a 2025, a 2030, 2035, 2040 and they just label them by the year and you know which one to buy because you know when you’re going to retire.

Ryan Isaac: So here’s what’s interesting though, is there’s a lot of companies that make different versions of those. If you compare 2040 funds across five different fund families, they’ll be very different, in their holdings, in their risk. Some people, it’s crazy because some as they get more conservative will, instead of only holding bonds they’ll start old holding like cash and CDs. They’re very different and costs are very different too. Some are really cheap and then some are very expensive actually.

Reese Harper: So let’s talk a little bit about the risks of these funds, right? I think the pros we’ve hit they’re simple, it makes sense, you know what to buy, they’re diversified. I really like using them in certain contexts. I think they’re appropriate for kids’ college funding. Like if you’re putting $100 a month away or you’re putting a small amount of money away for your kids college savings and you’re just doing it through your state. It’s not a bad way to go about doing it because they have such a short time horizon. I would prefer to use that or just a really conservative investment for my kids college savings because you just don’t have a very long time horizon.
By the time you start saving for your kid and by the time you’re ready to have the money. Most of the listeners here aren’t putting a lot of money away when their kids are zero one, two years old. They start when they’re a little bit older and so you still have a really long time horizon. Kudos to you if you’re doing it when your kids are born and in that case, you might have the option if you’re putting a lot of money away. I wouldn’t put them in a target date fund, but if it’s a small dollars, then it makes sense for employees that are in 401k plan, small dollars like these are not bad things. We’re going to talk about where we see them being used improperly and why we don’t think they work well for dentists who are accumulating larger amounts of money. And we just don’t think that they’re smart investments for people with large balances.

Ryan Isaac: Well, what’s the opposite of an employee with a small balance with maybe just one investment account and their whole lives. It’s the dentist with multiple accounts with very large balances, with a lot of moving pieces in net worth and various assets all over the place. That’s the opposite situation. But the problem is the same solution that the employee with the small balance is using is getting implemented by the dentist with the complete opposite situation.

Reese Harper: Because some dentists will go online, they’ll read that you should avoid paying an advisor and avoid hiring someone and you should do this on your own. And so if you go to Vanguard’s website and you look, you see that target date funds are there or you’re talking to a person over the phone about what to pick and they recommend using a target date fund is a good option inside your 401k and you think well if I’m using that inside of my 401k I might as well use that in my other accounts and save some more money. And what we find and we see a lot is dentists use target date funds as a way to make their investment management process really simple and still be able to self direct it.
So you can self direct and use target date funds because it makes your life easier and it keeps it really inexpensive. And so we understand the logic behind it and I don’t want to make anyone feel too bad that you’ve done that. I just want to highlight some things that maybe you haven’t thought about as it relates to target date funds and why that isn’t going to be the best thing for you as time passes. And if you start down that road early, it’s hard to unwind it later. And so without costs and consequences and so we’re going to go through some of these now.

Ryan Isaac: So the first one would be it’s one of the inherent benefits of target date funds, which is the automatically managed risk. And by risk we mean when you have more stocks than bonds in a portfolio, then you’re taking more risk in terms of volatility, right? So typically the way of thinking is when you’re younger you can afford to take more risks because you have more time to let it correct itself and right out so you can have more stocks and less bonds.
And then when you’re older, that shifts. So the inherent like automatic risk adjusting thing that’s happening in target date funds. While that’s helpful for some people, that can actually be one of the detrimental things for other people. The lack of control over … well, I guess we could back up. The way that they do this is something called the glide path. We could maybe explain that.
Glide path is what they call how they’re slowly making these funds more and more conservative. So if you chose a target date 2040, that’s the year you’re going to retire. As it approaches that year, it’ll start to become more and more conservative by adding more bonds than the stocks. They call that a glide path. And so there’s formulas and every fund family is different. Every fund family does it differently. If you look-

Reese Harper: And there are some really bad glide paths and there’s some that are actually pretty advanced. Pretty sophisticated that are better than others.

Ryan Isaac: It’s also important to point out that there’s two different types of target date funds. There is a to and a through. And so what those referred to as a to fund means that the most conservative point that it’ll get at will happen at your target dates. So if you picked the year 2040 and it’s a to fund, it’ll mean it’ll get more and more conservative up to the year 2040, but if you pick a through fund, then it’ll be a little bit more aggressive by the time 2040 comes around and it’ll go through your retirement. So those are two different types as well. So you have different companies with different formulas for how they make their glide path work. You have to funds and through funds and so-

Reese Harper: All you’re highlighting is there’s a million different kinds. You’re not saying like this is the right way and this is the wrong way necessarily.

Ryan Isaac: Yeah, there’s just a lot of different options, but that inherently becomes one of the things that can be a problem for people with bigger balances and with a lot of things on their balance sheet. A lot of different assets, private businesses and real estate and pre-tax accounts and after-tax accounts and a lot of money and a lot of net worth because now when you use these things, you give up your control over how you use your risk.
You won’t always have to take the same amount of risk in every account or you might hit age 50 and the fund is forcing you to take risks that the average 50 year old is going to take. But maybe you’re not in that situation anymore. Maybe your net worth and your assets and your other accounts for the business you’re going to sell means that you don’t have to be as conservative as you thought you would have had to have been.

Reese Harper: Okay. So what you’re saying is and like research this forever. So I’m going to try to like boil this down to a sentence here. You’re saying it’s dumb to invest in something that forces you to change your investment allocation just because you’re getting older.

Ryan Isaac: Just because of an age.

Reese Harper: So this one more time, it’s a stupid thing to do if you’re a dentist and you’re saying, “Hey, I’m going to just arbitrarily change my investment mix because I’m getting older, therefore I’m just going to change it.”

Ryan Isaac: And it’s not even a consensus like a worldwide. It’s a company specific formula. It’s not even like an industry wide consensus on this age is this risk. And people have little anecdotes and formulas. But depending on the company you chose to buy your target date fund from [crosstalk 00:18:34] dictate how you’re doing it.

Reese Harper: So [crosstalk 00:18:37] one more time here.

Ryan Isaac: Just kidding.

Reese Harper: I didn’t get it the first time. So what Ryan is saying is within these different companies there’s different mixes of investments and different choices that these companies are making about what it means to be conservative at age 55 or what it means to be diversified at age 45. You could have global bonds, you can have tips, you can have a certain percentage of emerging markets or international markets or no global and only domestic bonds or no tips. I mean each one of these company’s investment mixes are very different and the percentages that they put in each of these buckets are different and how they arbitrarily change the percentages.

Ryan Isaac: Well massively different, I was comparing two funds, two really popular fund companies last night and as the funds started hitting about 50% bonds or 50% conservative funds, one fund family was mostly bonds and the other one was like 33% of it was cash. And there’s a lot of people that wouldn’t want a third of [crosstalk 00:19:44] in cash.

Reese Harper: Which two were you comparing to?

Ryan Isaac: These were Fidelity and Vanguard.

Reese Harper: Okay. So you’ve got Fidelity and Vanguard in the same date?

Ryan Isaac: Yeah.

Reese Harper: Same date. One was what?

Ryan Isaac: I’m saying that as they got-

Reese Harper: One was 33% cash?

Ryan Isaac: As they got more conservative, they chose to do it in different ways. One of them was like mostly bonds and then another one was like some bonds, a ton of cash, some CDs, some tips. And you might not know it and you certainly might not even want that, you know?

Reese Harper: Well, ultimately I think it seems like in my experience, what I’m highlighting, I guess here is that it’s okay if you had accumulative, let’s say you had accumulative amount of $5000 per year, that you’re going to save throughout your life, you’re going to max a [inaudible 00:20:33] out and that’s what you’re going to do throughout your entire life. I personally don’t think it’s like the worst thing for you to have a target date fund. If that was going to be your only place you’re going to withdraw money from and that’s the only place you’re going to accumulate retirement in.

Ryan Isaac: That’s why they were built for. They were mostly built for participants of their retirement plan.

Reese Harper: I’m going put $5000 in a year. I’m going to do that for 30 years. That’s a total $150000 and it really simplifies my decision making. And the right target date fund it might not be a bad solution. I’d probably still opt for something different, but it’s not a bad solution for someone who’s just saying, “I don’t want to have someone do this and manage it. I don’t want to pay anyone to do this for me. I don’t trust anyone. One account, it’s pretty simple. I don’t really care. I just don’t want to talk to people and I want to like just have this be easy and say try to save some money.” I would make the argument you’re not going to save money if you don’t manage your account right. And throwing in a target date fund is not the right way to manage an account. But I still wouldn’t like be as critical of that situation.

Ryan Isaac: It’s not the worst thing.

Reese Harper: If you’re saving, if you’re talking about accumulating as much as the average dentist is trying to accumulate, which in almost all cases is going to be pushing seven figures and in most cases it will be many seven figure between three and $5 million to support a standard of living that they’re used to based on their earnings. You don’t want anyone arbitrarily changing your risk profile as time passes because there’s too many variables. What if you sell the practice for more than you thought and now you don’t need to withdraw from that account and your time horizons now changing.
So every year that you live, you have your own personal withdrawal plan that starts to adjust. Every year that passes you start to see more clearly how your personal withdrawal strategy is going to, depending on a lot of factors [crosstalk 00:22:32] and it depends on a million, at least 20 different inputs and some of those are taxes. Some of those are your income. Some of those are where you live, what real estate you’re going to own, what practice you’re going to have at the time of retirement and how large it’s going to be.

Ryan Isaac: How much is liquid versus like pre-tax versus how much is sitting in a liquidity brokerage accounts you have access to.

Reese Harper: How well your investments overall perform, how well the United States economy does, how will the European economy does, all these things are factors that affect when you’re going to withdraw from different accounts. And Dentists are going to have an after-tax account. They’re going to have a pre-tax account. Some of it will be 401ks, some will be profit sharing. Some will be defined benefit plan. Some will be an emergency fund, a municipal bond. Some will be a higher growth portfolio that’s after-tax.

Ryan Isaac: Proceeds from the sale.

Reese Harper: Proceeds from the sale of a practice, proceeds from the sale of real estate. Income from leasing real estate, social security income.
All these like income sources and liquidity sources affect your risk profile. And so it’s not good to arbitrarily change that because what we haven’t hit yet, and this is topic number B within this risk section is when the market goes through a period of decline, let’s say we’re in 2009 and eight okay and 2010 and 2007 to 2010 and let’s say that was the point where your target date fund was going more and more conservative during that moment.

Ryan Isaac: It’s nearing your retirement date that you had chosen.

Reese Harper: Is nearing your retirement date. Your retirement date happened to be 2012 and it was getting more and more conservative as you approached that date. What would happen is your fund is going to be shifting from stocks into bonds [crosstalk 00:24:28] or cash in that moment. So as the stock market is imploding, your target date fund is going to be selling off stocks at massive losses rather than you being able to [crosstalk 00:24:40] Because it’s forced to. And that’s what I want to get into the dangers now of putting all of your mutual funds together into one fund versus keeping them separate. And this is danger number one of that, which is it’s forcing you to buy and sell things at inopportune times based on market.

Ryan Isaac: This is like the rebalancing factor let’s hit that for a minute.

Reese Harper: Okay. Great. So rebalancing means when you shift money from one asset class to another, how about you hit a few things that you feel like are really bad about target date funds when it comes to rebalancing?

Ryan Isaac: Well, I think maybe for some context, let’s talk about a portfolio that has maybe five or six different funds in it. And how rebalancing works in that. Now, most people might know what rebalancing is, but just a reminder, rebalancing is when you choose a portfolio and the amount of risk you want to take and how you want to allocate assets into different things. US companies, international companies, emerging markets, real estate, stocks, bonds, growth value, large, small companies. How you choose to allocate your money.
That was your choice in over time, within days that will move away from your choice, right? Something will go down, something will go up, stocks will go up, bonds will go down something. And so the more time that goes on, the more out of balance that becomes. The process of rebalancing is just bring that back to your choice. That’s the whole point of rebalancing.

Reese Harper: Let me say this in a way that I would think about it too. Sometimes hearing this from two peoples it’s healthy.

Ryan Isaac: I like it.

Reese Harper: In my mind, I would just think of your portfolio in six asset classes. Just think of six things, and it’s not really this simple, but it’ll help you conceptualize it. There’s stocks in the United States, there stocks in Europe, their stocks in Latin America and China and a small countries. So you’ve got those three big groups of stocks. You have real estate stocks that are publicly traded and then you have a couple types of bonds. You’ve got corporate bonds, and you’ve got government bonds all around the world. You can have these six investments.
Everyone chooses to do different variations of that. Some people will be like, “Well, I want my US stock to be broken up into four investments, or I want mine in six US investments instead of one.” But a simple, really well diversified portfolio really could be done with six different mutual funds or six different DTFs. So if you have those six what Ryan is saying, is every person’s going to choose to have a different percentage in each of those based on your own personal age and choices and preference for growth versus safety. Okay. So if you want a lot of safety, you’re probably going to have a little bit different mix than if you want a lot of growth. But that’s the general drift and these target date funds, that’s all they’re doing.

Ryan Isaac: And they’re doing the same thing.

Reese Harper: They’re basically grabbing those six investments, putting them into one investment and then saying, “We’ll make the decision for you about when to shift between one or the other.” So what’s the problem of doing it through the target date fund rebalancing like we were saying? I just want you to hit your view of that. What would happen in 07 versus 2010?

Ryan Isaac: Well, to go back to the normal portfolio where they’re broken out. You have a choice. So let’s say you save 3000 bucks a month and the money comes in, you have a choice to say, “Oh, emerging markets went down and my US went up. I can avoid some taxes here by not selling my US. I’m going to put my new money on the emerging markets and that’s how I’m going to rebalance my account.” What I’m saying you have a choice when they’re split out.

Reese Harper: So when you have a choice for and that that choice matters for a few different reasons.-

Ryan Isaac: Taxes.

Reese Harper: … It matters because if one thing goes down and let’s say you’re doing an automatic draft for $5000 a month and you want to invest money and one of those things goes down more than the other, you have a choice to say, “I’m going to put a little bit more into the one that’s down than I am the one that’s gone up.” For example, in this calendar year where you know in the last couple of years, the ones that weren’t doing so well, were the emerging markets and the developed markets, and by putting money into those a little bit more because they were down more, then that would have brought your account up to balance.
It wouldn’t have been like a guess you are making. It just would have been, let’s say your choice was I’m going to have them evenly distributed among all six. Well, the ones that didn’t do good, you’d see those going down and you could say, “While they’re going down, I’m going to go ahead and put a little bit more in them.”

Ryan Isaac: Which is your chance to buy cheaper investments without having to know how to time the market. That’s your ability to buy cheap stuff without having to time it.

Reese Harper: I’m just trying to highlight, it’s not really like rocket science. It’s just one thing goes down. You don’t just throw it the same at it every time. And inside of a target date fund, it’s not working that way because the fund can’t make decisions about each of its investors and say, “Let’s help them out.” It’s just trying to hold to a glide path that will take you to the point where you’re really conservative at a certain age and they’re more concerned with protecting their liability. Than they are-

Ryan Isaac: That’s why they got popular.

Reese Harper: That’s why they got popular because it helps a lot of corporations and financial firms be able to give investors an option that doesn’t force them into something risky.

Ryan Isaac: That’s why 401k plans got sued all the time was inappropriate investments and too expensive of investments and that literally solve that problem.

Reese Harper: And it’s great for that. I mean in every dentist you should put target date funds in your 401k plan for your employees to pick from for that same reason and we do that with all of our clients. Every client that we’ve got, even though they’re personally not investing in a target date fund, they’re our target date funds in their 401k plan for clients to pick from, for employees to pick from.

Ryan Isaac: The third point would be when you want money out or when you’re taking the money out, like withdrawals and if you’re trying to rebalance the withdrawals a little bit the same thing. You have no control over that. Like you said, they will be taking heavy losses by selling equities in a Dow market they’re going to do it anyway. They have to do that stuff.

Reese Harper: They have to give you … so let’s say you’re a dentist and you say, “I’ve got money for retirement, I’m going to save money and there’s a chance I might need a little bit of it for whatever reason. Maybe I want to buy a commercial building, maybe I have to do a remodel on my home. I want to save my money for the future, but I don’t want to like promise that it’s all going to be tied up for a time.”

Ryan Isaac: I might need some bitcoin.

Reese Harper: Yeah, no. So you need to get money out of this account potentially. So a lot of people, what they’ll do is they’ll start saving money into a target date fund. They’ll get down the road and realize they need some money out. There’s a couple of big problems with that. Like Ryan said, what if you’re, let’s say like instead of having those, let’s say six investments, you’re in one investment, you’re in that target date fund. The only place for you to get money is out of that one mutual fund and they’re six investments inside of it that you can’t really see. But if you want $25000 out, if you want $100000 out, you have to sell all of them at the same time regardless of whether one is doing bad or one is doing good or-

Ryan Isaac: Taxes on one and not taxes on the other.

Reese Harper: Well taxes is a whole separate subject. But let’s just talk about performance. If you sell something that’s not performing well, you’re going to take a hit. And that’s what has to happen inside of a target date fund is every year they are shifting money from one investment to the other regardless of whether it’s a good time to do that or not because they are on a date path, they’re not trying to understand your goals path as a personal plan. They’re just trying to change it by date. So your performance isn’t able to be controlled in periods of bad markets. And that to me is a really scary thing when you want withdrawals I don’t want to be selling US stocks in 2009 and I don’t want to be selling-

Ryan Isaac: Describe the way it works. When someone has a six positions in a portfolio and they call and say, “Reese I need 10 grand, I’m taking my kids on vacation.”

Reese Harper: So the alternative is if you have a mix of let’s say those six and you call and say “I need 25000 or I need 50000,” Then we can look across all six of them and say, “Which one of these is up the most right now? And is doing the best from a performance perspective that will allow us to give you that money without having it adversely affect your profit and losses, locking in some loss.”
The next thing that we want to talk about is taxes. And this is huge, talk about what happens when someone, let’s say “I’m going to put $10000 or I’m going to put thousands of dollars a month away into a target date fund. And what’s going to happen with that over 10 years? What happens to that from a tax perspective?”

Ryan Isaac: Oh, you have capital gains.

Reese Harper: Okay. And what are those?

Ryan Isaac: Yeah. Capital gains is when the stuff you buy grows in value.

Reese Harper: So you’ve got like-

Ryan Isaac: You haven’t realized it, that that’s different than dividends or interest that kicks off and you get your little $10.99 every year for your accounts, you got to pay income tax, ordinary income rates, capital gains, when it builds up in value, you haven’t sold it yet, so you don’t pay tax on it yet. You pay the tax when you sell it.

Reese Harper: So let’s say we have $100000 of contributions and I have a $200000 account value. I have $100000 there that I have not paid taxes on. Now in a target date fund anytime I want to get that money out of that account, I have to pay taxes because all of my investment is tied up in this one investment that has a capital gain in it and the only way I can get money out is by selling shares of that one investment and getting taxes on it. If I want $10000 well, I’m going to sell $10000 and I’m going to incur capital gains taxes on that sale.

Ryan Isaac: As opposed to in a different portfolio.

Reese Harper: If we had those six investments, you explain that. What would we do if we have those six investments?

Ryan Isaac: If tax was the main driver of the withdrawal in this scenario, because performance might be the other side, but you can choose to take money out of certain parts of your portfolio that haven’t performed as well. Maybe they’re just not up as much. You’re not going to lock in loss.

Reese Harper: Here’s the trick for me. Most people don’t all carry a 100% stock. Most people are not allocated that way and I don’t recommend it. I always recommend having some bonds in your portfolio, whether it’s a three year reserve, even if you’re young and you’re accumulating, you’re going to have a 20% of your assets, at least in liquid conservative bonds. The difference between bonds and stocks is bonds pay interest income where stocks give you capital gains. Bonds don’t normally give you capital gains. Bonds pay interest income-

Ryan Isaac: Not nearly the same magnitude.

Reese Harper: No and rarely do they. Usually if you bought a bond, which is another episode for another day, you’d pay $10000 for it. It pays you interest and then you get your 10 grand back when it matures. They’re not designed to create capital gains. And so if you’re looking for cash, the place you would get the cash without incurring a taxable event would be from your bonds. Within your six investments, you might have two of those that are bonds and you can say, “You know what Reese I want 30000 but I don’t want to incur any capital gains tax is to get that, let’s take it out of my bonds. And then next month and in a few months I’m going start saving again or I’m going to save immediately next month again. Let’s just replenish my bonds.”
Okay well that’s literally doesn’t do anything from a negative to you. It’s a perfect way to get liquidity.

Ryan Isaac: It’s not locking in losses. It’s not generating big taxes.

Reese Harper: Because there’s no capital gains that are likely there. Those pay interest income and they usually stay flat. You just get your percentage bonds. These bond investments pay interest into your account it goes into the money market and [crosstalk 00:37:04] that’s your return. And the stocks are the things that appreciate a lot. But when you invest in a target date fund, you don’t have the option to be able to sell everything. I just want money out of my bonds Reese. Like, “well I’m sorry you’re in a target date fund. I can’t give you money of your bonds.-

Ryan Isaac: Sorry sir.

Reese Harper: … I have to give you your entire investment.”

Ryan Isaac: Selling it all.

Reese Harper: And then you have to pay taxes on it. Even though if these were broken out into five or six, I could’ve done that without any penalty, any tax, and it wouldn’t have hurt on performance. And so bonds are there for liquidity. We all need them throughout our lives. And I do think it makes more sense to split them out, especially when you start accumulating large amounts money.

Ryan Isaac: That’s good.

Reese Harper: That’s a rant. The reason I’m frustrated by this and you can sense it in my voice, is I continue to run across people that say I don’t need a financial advisor because I can do this on my own. I just invest in target day funds. And for me, I just feel like here’s the thing, you’re not realizing from that comment. And I’m not saying you can’t. Not everyone needs a financial advisor. There are plenty of dentists out there who are very capable at managing their own money and they’re going to do it just fine.

Ryan Isaac: We see you tip of the hat.

Reese Harper: Tip of the hat. I get emails from who have spent more money, I’m convinced managing money than they have doing dentistry and I’m impressed. There’s literally dentists that I want to hire-

Ryan Isaac: Some people love.

Reese Harper: … to be financial advisors and we continue like [crosstalk 00:38:33] There are many that I might do this you’re the perfect financial advisor. How did you learn so much? But there’s a big swathe in the market that they go online. They read something from some Bogle head at Vanguard.

Ryan Isaac: That it’s not an insult. That’s actually what people are called that follow the Vanguard philosophy.

Reese Harper: John Bogle wrote a book called the Little [crosstalk 00:38:56] Common Sense Book Investing. It sounds like, “Oh it’s bogle,” it sounds like a negative thing, but a Bogle head is someone who’s like a strong advocate of DIY and everything and doing stuff on your own.

Ryan Isaac: Even though Vanguard itself is not.

Reese Harper: And Vanguard surprisingly enough like has really strong research papers that oppose this view of entirely self directed investing. I worry that too many dentists naively will read one or two lines because there’s a ton of bad financial advisors out there. So you meet one or two bad financial advisers, you go to lunch, you get tried to get sold some insurance, whatever, and you never meet someone who you trust and say go fine. At least I can go online and do this myself and no one’s going to like steal money from me and no one’s going to lie to me.

Ryan Isaac: And it’s cheap [crosstalk 00:39:49].

Reese Harper: It’s functional.

Ryan Isaac: Balanced and diversified and it’ll get conservative when I get old.

Reese Harper: And there’s evidence of it actually working and your friends are advocating for it because they’ve done it and it’s working for them. And so rather than saying, is there a better way to do this? And they just unfortunately never bump into someone who actually can educate them and show them a different point of view.

Ryan Isaac: Out of all the things we’re going to recap some of this stuff. But I think out of all the things that I was reading over the last few days about this one, I wish I knew where this was, I’m going to have to go find it now. But one of the downsides that was listed in one of these articles about target date funds was they said it’s an educational disservice to investors. That the popularity of target day funds, the ease of use, it’s an educational disservice. And I think it’s just for the same reasons you were talking about there.

Reese Harper: That’s a good quote. I like it. Anyway. Well thanks for being a part of this rant, Ryan. I really appreciate it.

Ryan Isaac: I’m glad to be a part of it. Makes me feel included.

Reese Harper: Let’s-

Ryan Isaac: Thank you.

Reese Harper: … finish somehow.

Ryan Isaac: Let’s finish somehow. So we just tweak this cut right here. Let’s just be done. Just shut it off. No, what we’re going to tell everyone instead is that we’re really excited that after, how long was the website in the making you guys?

Reese Harper: Years.

Ryan Isaac: I mean, seriously.

Justin Copier: Just 12 years.

Reese Harper: I mean it’s been six to 12 months probably. That’s one a year of hard work.

Ryan Isaac: And not just like designing, it’s not just a layout of a website. It’s content and what we’re trying-

Reese Harper: Education library.

Ryan Isaac: You want to talk about this for a second? What Ryan is saying is we’re really excited that we finally launched a new website after, probably a couple of years of thinking about it and working on it and it’s full of things that we’ve been wanting to share and teach dentists across the country.

Reese Harper: Yeah. Why? I’ve been really excited because I know I can see people spending more time on it. I mean it’s the average [crosstalk 00:41:53] on our website right now is pretty impressive. I think a lot of people are learning a lot from it and that makes me excited because even though I sound like a cranky old man, I am 35. [crosstalk 00:42:06] I am aging as fast as I might sound like I’m aging from the tone of my voice. But I really do care a ton about literacy around personal finance for dentists and I hope that comes through. I will come across a little bit bitter about bad advice that’s being delivered out there.
Because I see people paying unnecessary taxes, underperforming the possibilities of what their investments could do if they did it properly. And I just really feel like a financial advisor. A financial advisory firm, like ours has a lot of great insight and I wanted to put that on a website and continue to allow dentists to have access to information that they might not be getting anywhere else. And so our education libraries really robust. We’re going to continue to add courses and continue to supply more information to hopefully help people, whether you’re choosing to self direct, which I again totally respect the people who have gotten to the point where they feel like they are capable of doing that-

Ryan Isaac: And they love it and are interested in it.

Reese Harper: Fundamentally still feel like, if you have another business that you could reinvest your time into like a practice expanding your business, adding an associate, opening another location-

Ryan Isaac: Marketing better.

Reese Harper: … marketing better. I don’t feel like financial planning and asset management is something that as long as it’s being outsourced to someone competent, doing it the way you would do it. If you could do it on your own or had the time to, I still think you’re better reinvesting your time elsewhere. But there are people who just love it and want to do it on their own. So our contents not meant to pigeonhole you and saying you have to use us or you have to use an independent advisor. But we do have a strong preference for doing things the right way. We just want to make sure everyone knows the right way to do things.

Ryan Isaac: So on that education library, we’ve got videos, new videos, they’re short little educational videos that talk about our philosophies, our processes, our elements, planning platform that we’ve built, our investment philosophies and a lot of other topics, savings, debt, taxes, all this kind of stuff. But like you’re saying we care a lot about educating people, whether you work with us or not. Even at our peak 30 years from now we will still be just a small segment of the market we work with and everyone else we want to be able to teach something helpful to you along the way. So the new website does a really good job of that. While you’re on there, you can submit a question to us.
So on the podcast tab go to the website. So it’s dentistadvisors.com click on the podcast tab and there’s a little button that says submit a question and you can submit an anonymous question that we’ll answer on a future podcast. We’d love those questions are really helpful. And another thing you can do is you can book a free consultation. So if you want to chat with us, if you have questions about your target date funds or other investments that you’re holding or questions about savings or taxes or insurance or anything go to the website, dentistadvisors.com and book a free consultation. We’ll have a chat and let’s see what we can do to answer your questions or pointing in the right direction, or call us 833-DDS-PLAN. So thanks for joining us.

Reese Harper: Carry on.

Investing, Retirement Plans