Robo Advisors vs. Target Date Funds – How Are They Different?

Daniel Penzing
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Target Date Fund Basics

When investing in mutual funds, it’s very common to have the option of picking a specific goal or target date. That’s where target-date funds come into play. So let’s discuss target-date funds …

Target date funds are typically considered to be “set it and forget it” investments. They are intended to allow people to invest in one mutual fund and then simply pick the date that they expect to retire. Once that date comes, they then have the option of rolling over the mutual fund balance into an IRA or taking the distribution and spending it. Target-date funds are a type of fund that gradually get more risky as the date approaches.

Target date funds are a good choice for those who are looking to get the maximum amount of diversification in one single investment and don’t have the time or interest to really research the individual investment opportunities and make changes along the way. Instead, they can simply pick a fund with the appropriate date range and then simply let it ride.

Target date funds tend to be best for those who are very conservative when it comes to their investment decisions because they aren’t very flexible. Since target date funds have a limited number of investment options, there’s a limited amount of adjustments that can be made.

Robo Advisor Basics

Here's a list of all the Robo Advisors we've reviewed:

Let's get something straight. Your personal financial situation matters much more than whether you choose a robo-advisor or a target date fund. Those are both tools that can help you, and they are different enough that their boundaries can blur for some people.

But, let's talk for a minute about how they differ. Robo-advisors are new and have access to better technology and funds with better management. That's not to say there aren't any bad funds to be found in the robo-advisory universe, but at the moment they have an advantage over target date funds in the categories of:

  • Accessibility
  • A broad array of fund options, including index funds, managed ETFs, and more
  • Ease of investing
  • Better technology to work with

Target date funds are great! We love them and they are still relevant for many people. However, the reason robo-advisors are flourishing is because they are putting the spotlight back on the investor instead of the fund.

Target date funds are a good option if you want to just "set it and forget it" or you want a one-stop-shop with one fund that will take care of your entire financial life, but they shouldn't be your nirvana. This isn't because of the fund. It's because of how people are using them.

Robo Advisors vs. Target Date Funds

Robo Advisors vs. Target Date Funds: Which should I choose? If you’re in the market for a new investment strategy, sorting through your options can be difficult.

Although they both offer a relatively quick and easy way to diversify your portfolio and make investment decisions, you need to understand how they differ and how best to use each.

Target date funds are a retirement investment vehicle that are typically managed by a human asset manager who makes all portfolio changes, based on the Target Date.

The funds are either actively or passively managed, and often have a lower expense ratio than do most other mutual funds. Like most mutual funds, the date of the specific fund to which these refer will gradually move forward, meaning there is a glide path set for the portfolio in terms of risk and volatility.

As the fund accumulates assets, changes are run by a human asset manager. While there are no transactions within the fund, these are monitored through a recurring portfolio analysis process.

Robo advisors are becoming increasingly popular. They offer digital portfolio design and management.

Because they manually review each account, they carry a higher cost but are able to provide a higher level of service.

Robo advisors are typically set up to take care of smaller assets. They also usually focus on a particular segment of the market, lessening risk.

401(k) Plans

Are an attractive option for young workers or even older workers who are new to investing. Since a 401(k) is inexpensive to set up, portable, and simple, it is a great way to get started.

Most employers offer these plans, so with a 401(k) plan, employees can contribute a percentage of their pretax income to it. It is a way to save for retirement and build wealth for the future.

Target date funds are designed for those without a lot of investing experience. They have various risk levels across several different timetable periods so that as the worker approaches retirement, the risk level drops to zero. The downside is that people who use target date funds earn on average, lower returns.

Robo-advisors allow investors to have more control over their investments. As the investor, you can create your own investing strategy with set parameters, and the robo-advisor will manage it based on your portfolio needs. The downside to this is that these services are usually more expensive to use with average returns a couple percentage points lower than target date funds.

So I ask what service are you looking for? If you are an individual who knows how to invest, then you may be better off using a robo-advisor. If you want something easy, a target date fund is a good option.

Which Option Is Best for You?

As you are likely already aware, there are two major options when it comes to investing – target date funds and robo advisors. The primary difference between these two investment methods is the degree of control you have over your investments. With robo-advisors, it’s possible to completely automate your investing plan by simply answering a few questions about your investment goals and debt levels. You can then let your robo-advisor do the rest. However, with target date funds, you will need to contribute to the funds every month or year, and you will also need to perform any necessary rebalancing. So which one should you choose? It ultimately depends on your individual situation and preferences, but finding the right investment strategy for you is an important first step.

Now that you have a better understanding of the differences between robo advisers and target date funds, let’s take a more in-depth look at each one.

Argument For A Target Date Fund

"No one is the best investor in every single market situation, so it is smart to split your assets between different types of funds that each have different goals and allocations," says Richard Hynes, vice president of retirement and college products at Fidelity Investments in Boston. "Pulling from a pool of assets that are automatically reallocated according to your risk tolerance as you age instead of trying to succeed in every market at the same time makes it possible to minimize your investment risk and optimize your chances for good returns."

Hynes says that while before retirement, you're likely to have a fairly full plate with career, family, and other responsibilities, once you're retired, your leisure time is likely to increase. You may enjoy golfing, traveling or volunteering, but as your time stretches before you and your career obligations fall away, you may find those new hobbies cost money.

"That money does not need to come from your nest egg," Hynes says.

Nor will it if your portfolio is divided among the stocks, bonds, alternatives, real estate, and other options that make up a target date fund. It likely will continue to grow, and you will continue to earn the returns of that fund while the fund managers remain focused on their work.

Argument for a Robo Advisor

Robo advisors are growing in popularity. In fact, an article in Wealth Management stated that over that past year, robo advisor assets under management grew by over 80%! But what is a robo advisor?

A robo advisor is an automated investment service. It is a sophisticated computerized system that helps you invest your money in a variety of investments for your best interest. It is easily accessed on your computer, web enabled device, or mobile phone. You enter how much money you have to invest, your time horizon, what you want to invest in, as well as what your risk level is. The robo advisor gains your risk profile by having you respond to a series of questions. The more questions you answer, the more information the robo advisor has to work with. They may also look at your income level and make assumptions from it. For example, if you are young with low expenses, then they assume you have some time to wait to grow your money vs an older person with high expenses. They will also make assumptions on your earnings and where you earn your money from. Robo advisors are generally connected to many different brokerage firms and for a percentage of the assets under management, will provide you with a top quality financial plan.

How does a robo advisor make money?