Question

There’s a fairly new product for retirement mutual funds that target your date of retirement. I’m not sold on the product. I’m 59 years old. Over the last 10 years the Vanguard Index500 fund averaged a 10.49% annual return. The 2025 (retirement target date 6 years from now) retirement fund has averaged a 5.13% over the last 10 years. At age 49 I had $200,000 in retirement funds and for the next 17 years (to age 66) $12,000 per year is invested in the fund. (Assume all monies are invested at the beginning of the year.) Now we don’t know what future returns will be but let’s speculate they both will perform identically to past history. At age 66 (7 years from now) how much will I have in the Index500 fund? How much would I have in the 2025 target fund if I listened to an investment “expert” when I was 49 years old and invested in the retirement target fund? In dollars, how much was the financial mistake investing in the 2025 target fund?

Answer 1

We have,
at age 49, funds accumulated till now = $200,000

Now, we'd be investing for the next 17 years till the age 66, annually = $12,000

Case 1 - When we stayed invested in Vanguard Index500 fund
historical average returns = 10.49% .

Assuming the fund will perform identical to historical returns,

we need to calculate the Future value of the investment
Using Excel
we use the function, FV(rate,nper,pmt,[pv],[type])
where, FV= future value
rate= returns earned per year = 10.49%

nper= number of periods of investment= 17

pmt= periodic payments done annually= $12,000
pv= present value= 200000
type = beginning o the year(1) or ending of the year(0).
Therefore, putting all the values in excel function as given below
=-FV(10.49%,17,12000,200000,1) and press enter to get the answer(include the '=' sign in the formula)
Total funds at age 66 = $1,652,841.50
( we used the '-' sign before FV since it is a cash outflow hence excel will give a negative answer, so to get a positive answer, apply the '-' sign

Case 2- When invested in 2025 target fund,
average historical returns = 5.13%

present value= 200000,

other values being same, we use the excel FV function and input values as below

=-FV(5.13%,17,12000,200000,1) and press enter

Total funds at age 66 = $797860.56

Difference = $1,652,841.50 - $797860.56= $854,980.95

Hence investing in 2025 target fund will have potentially reduced the total fund amount by $854,980.95.