Target-date funds are not all created equal. Therefore, the analysis involved with them is one of apples and oranges.
As is the case with other types of mutual funds, target-date funds have varying styles, allocations and expenses. In fact, even if you were to compare two target-date funds with seemingly identical objectives, such as the time frame between today and the fund’s stated target year, you might take a closer look at the allocation and holdings and find some fundamental differences.
To illustrate the point of these differences, we’ll highlight what we believe to be the best target-date funds for three different objectives: 1) Short term, or one to three years; 2) intermediate term, or five to 10 years; and 3) long term, or 20 to 30 years.
We’ll then show how the winners differ from other target-date funds within their respective categories.
And with that introduction, I give you the three best target-date funds:
Best Target-Date Funds: Vanguard Target Retirement 2015 (VTXVX)
Expenses: 0.16%, or $16 annually per $10,000 invested
Minimum Investment: $1,000
Investors with short-term objectives, or those looking for a low-cost conservative allocation fund that will grow more conservative over time, will like Vanguard Target Retirement 2015 (VTXVX).
The reasons VTXVX wins the short-term category is that Vanguard’s target-date funds are generally lower in cost and lower-to-average in market risk compared to target-date funds in other fund families.
Out of nearly 200 target-date funds reviewed, the expense ratio of 0.16% for VTXVX was lower than all but one of them.
The asset allocation was approximately 48% stocks, 47% bonds, 4% cash and 1% “other.” While this allocation is close to average for the 2011-to-2015 category of target-date funds, the rock-bottom expenses and passively managed holdings have proven to be beneficial, as evidenced by performance ranks that are consistently and significantly above average.
The holdings for VTXVX are a solid mix of Vanguard index funds: Vanguard Total Bond Market II Index Fund (VTBIX), Vanguard Total Stock Market Index Fund (VTSMX), Vanguard Total International Stock Index Fund (VGTSX), Vanguard Total International Bond Index Fund (VTIBX) and Vanguard Short-Term Inflation-Protected Securities Index Fund (VTIPX).
Best Target-Date Funds: American Century One Choice 2025 (ARWIX)
Minimum Investment: $2,500
Investors with at least five to 10 years to go until their investment objective, such as retirement, will do well to consider a fund like American Century One Choice 2025 (ARWIX), which has a good balance of reasonable expenses, conservative allocation and historical performance.
When investing for a financial goal like retirement, most investors won’t want to bet their nest eggs that the next 10 years will be a time when loading up on stocks is a prudent strategy. But with that said, bonds won’t likely have the greatest decade ahead either.
For this reason, a well-balanced choice like ARWIX can help investors sleep better at night when they’re just a handful of years away from retirement. The asset allocation for ARWIX was recently about 53% stocks, 37% bonds, 9% cash and 1% “other.” The bond and cash allocations are above average for the target date 2021 to 2025 category.
The 5.9% annualized return for ARWIX over the past 10 years ranks ahead of 94% of similar funds. A significant contributing factor to this rank is its 2008 performance of -25%, compared to -34% for the average target date 2021 to 2025 fund.
The holdings for ARWIX were recently a diverse mix of 19 American Century mutual funds, including American Century NT Diversified Bond Fund Institutional Class (ACLDX) and American Century NT Large Company Value Fund Institutional Class (ACLLX).
Best Target-Date Funds: T. Rowe Price Retirement 2040 (TRRDX)
Minimum Investment: $2,500
The best target-date funds for long-term investors are funds like T. Rowe Price Retirement 2040 (TRRDX).
T. Rowe Price tends to tilt their allocations more to stocks than most other target-date funds, and this kind of portfolio structure will likely win in the long run, assuming history has any rhyme or reason to it.
The asset allocation for TRRDX was recently 87% stocks, 10% bonds and 3% cash. This edges out the 84% stock allocation of average target-date funds in the 2036 to 2040 target year category.
The added stock exposure has thus far paid off for shareholders, as is evidenced by the 6.9% 10-year annualized return, which ranks ahead of 99% of category peers. However investors should be prepared to fall behind category averages over short periods when stocks have seen significant price declines.
The bottom line on target-date funds is that the allocation is the most important aspect in choosing the best fund and matching it to the objective.
While high-ranking performance is a plus, investors are smart to look under the hood at asset allocation before buying target-date funds.
As of this writing, Kent Thune did not personally hold a position in any of the aforementioned securities. His No. 1 holding is his privately held investment advisory firm in Hilton Head Island, SC. Under no circumstances does this information represent a recommendation to buy or sell securities.