Are you familiar with the concept of sabermetrics? The word grew from Society for American Baseball Research- SABR or “saber”. This society collects a wealth of data on every baseball play, player, and tactical situation. Sabermetrics originally referred to an intense study of baseball performance using high level math and statistics. Proponents of sabermetrics would use this data to find an optimal strategy for games. Sabermetrics completely changed baseball over the past 20+ years. And not always for the better. As the games have become optimized for winning, they have become less watchable. Baseball has less than half the viewership that it had 20 years ago. Tony Isola shares how there are parallels between how sabermetrics ruined baseball and a sabermetric approach to personal finances could ruin your financial journey.
Winning games but sacrificing fans in the process is a path to extinction.
There’s a correlation to personal finance here.
Emotions, not numbers, fuel our brains.
Sometimes giving financial advice by the book wins the battle but loses the money war. ~Tony Isolda
Over-optimizing your finances can turn even the most dedicated wealth-builder into a crabby zombie. Money is not just a formula. It is also emotional. For example, mathematically, it does not make sense to pay off your mortgage early. However, paying off your mortgage could be a major motivational milestone for you and encourage you to save more money than you would otherwise. In that case, taking a less optimal path actually helps you achieve a better outcome. In the end, it’s important to know the sabermetric formula for building wealth. But ultimately, your path does not need to follow to book exactly.
Target date funds are a popular investment in 401(k)s and other retirement accounts. These mutual funds, also called lifecycle funds, allow someone to invest in a single mutual fund for retirement. Target date funds are not a single mutual fund, but instead a mutual fund that owns many mutual funds for even broader diversification. Lifecycle funds automatically adjust the ratio of stocks to bonds as you approach the target date so that your asset allocation is an appropriate mix of risk and return. Once someone decides to invest in a target date fund, they don’t need to touch their investment until retirement.
First off, a target date fund is a fund-of-funds. They generally include US stocks, international stocks, and bonds. There are many different target date funds which can be active or passive, and may contain cash, TIPs, and other slices of positions (emerging, REIT, commodities etc.).
They are most commonly used in defined contribution (401k, 403b) plans; participants are defaulted into target date funds by their employer. They typically are labeled at 5-year retirement intervals (2020, 2025, 2030, etc.) which indicate the year you are likely to retire. Gradually, they dial back the percentage of stocks in favor of bonds and other safer assets. ~FI Physician
One important point in the article that target date funds are horrible to hold in taxable brokerage accounts. Since these funds are constantly rebalancing, they are creating capital gains that you cannot control and you can end up with a nasty tax surprise. In addition to this general warning about target date funds, the article points out that target date funds are often too conservative in retirement and also that there is a wide variability in the asset allocation in retirement. Beyond these complications, target date funds do not give you flexibilities over your withdrawals in retirement. For instance, if the market experiences a downturn, you may wish to sell bonds from your portfolio to fund your lifestyle rather than stocks. With target date funds, these are sold at a fixed ratio (determined by the target date fund portfolio at the time). If you are currently investing in target date funds, you may wish to think about how you plan to manage these funds in retirement.
Gov Worker also covered lifecycle funds in his latest post. Federal employees don’t have a 401(k) but instead a similar type of account called a “Thrift Savings Plan” or TSP. The TSP does not allow you to invest in mutual funds. But instead, employees must choose from one of 5 trust funds managed by the office of the comptroller of the currency. These trust funds follow major indices such as the S&P 500 or the MSCI EAFE International Stock Index. In 2020 the TSP introduced Lifecycle (target date) funds in 5 year increments.
While investors can build their own portfolio from these 5 individual TSP funds, the TSP developed Lifecycle Funds in 2005. There are many different Lifecycle Funds, each with a target date.
The TSP automatically adjusts the target allocation of these target date funds as you approach the target retirement date. This allows investors to place all of their money in a single fund without having to ever rebalance their portfolio.
Gov Worker notes that new employees are automatically enrolled in the Lifecycle funds at 5% of their salary. One down-side of the TSP Lifecycle Funds is that they are more conservative than many of their private sector counterparts, especially in retirement. On the other hand, federal employees can be more aggressive with their asset allocation since they have a guaranteed FERS pension and social security in retirement. If you’re a federal employee who is trying to manage their TSP, check out the article or one of the other articles in Gov Worker’s TSP School.