Target-date mutual funds are commonly found among company-sponsored retirement plans such as 401ks and 403bs. But there’s a wide chasm separating the wheat from the chaff.
These “set-it-and-forget-it” funds own a broad mix of stocks and bonds that slowly changes over time. The farther out your retirement date, the greater percentage of assets will be skewed towards stocks as a riskier growth asset. The portfolio will then begin to balance itself toward bonds and cash to become more conservative the closer you get to retirement.
The beauty of this setup is that it creates a one-stop shop for investors who don’t know much about asset allocation or portfolio strategy. The fund does all the work of proper diversification, rebalancing and targeting to a suitable risk tolerance so you can continue to work, save and invest.
If you have most of your money in a 401k, then there is likely just one fund company with a narrow menu of target-date funds. It won’t be hard to figure out which one to choose. However, if you are looking to purchase one of these options from a more flexible brokerage platform in an IRA or taxable account, you have far more options at your disposal.
Not all target-date mutual funds are created alike. They often differ in their asset allocation, fees, and overall performance. Some investors may choose a fund simply based on the company that manages it. However, it’s worth evaluating some of the top options to ensure you are making the proper decision to suit your needs.
For this analysis, I looked at the target date funds in the 2030 category at Vanguard, Fidelity Investments, T. Rowe Price Group Inc (NYSE:TROW) and American Funds. This segment generally represents investors who are looking to retire in the next 13 to 17 years. It also is where a significant bulk of assets are represented among these four competitors.
The competition includes:
- Vanguard Target Retirement 2030 Fund Investor Shares (MUTF:VTHRX)
- Fidelity Freedom 2030 Fund (MUTF:FFFEX)
- Rowe Price Retirement 2030 Fund (MUTF:TRRCX)
- American Funds 2030 Target Date Retirement Fund Class A (MUTF:AAETX)
The following table represents the most recent statistics of these target-date funds as of Dec. 31, 2016.
The most obvious observations on this table should come as no surprise to anyone. Namely, Vanguard is the lowest-cost option with an all-in expense ratio of just 0.15% annually. The remainder of the group is clustered in the 70-75 bps range, which is about average for actively managed mutual funds.
Furthermore, it should be noted that the American Funds share class is an “A share,” which includes a front-end sales load. That may be waived in some cases, but may be an immediately disqualifying factor for many investors. Returns for AAETX are reported on the net asset value of the fund performance without including the sales load.
One of the more surprising recognitions for this group is how heavily invested in stocks these portfolios are.
Without digging into the data, I would have suspected that a 10- to 15-year time horizon would have been closer to a 60/40 or 70/30 mix of stocks and bonds. All of these portfolios are positioned with greater than 70% exposure to stocks, with Fidelity on the gas at an 84% allocation.
The American Funds option is the only holding with any significant level of cash, which is likely a result of their active mandate. The portfolio management team may be expecting a correction or in the process of rebalancing to deploy that remaining capital. These levels will ultimately change over time by lowering allocations to stocks and upping allocations to bonds or cash as we get closer to the year 2030.
Investors should also be cognizant that the underlying diversification within these four funds is achieved by owning other mutual funds within the same fund family. This “fund of funds” structure allows the manager to deploy capital toward other in-house managers and simply adjust their exposure limits accordingly. This means there are fewer positions to manage, while still achieving a highly diversified structure.
Another interesting realization from this analysis is the clustered returns of these four options. Despite varying fees and percentages in each asset class, there has been very similar performance across all funds in this study over multiple time frames.
That is likely a result of the fund managers sticking with tight guidelines and not swinging for the fences with any bold market calls. This type of clustering should be seen by investors as a positive sign of steady alterations and reliable strategy implementation.
The Bottom Line
Target-date funds may be scoffed at as over-simplified, quasi-index funds by experienced investors who prefer greater control over their assets. However, these tools can be an effective means of retirement savings and growth for those who have found poor results in their own fund selection or active management.
Investors considering these strategies should select a fund based on their potential retirement date, embedded fees and overall asset allocation as it relates to their risk tolerance. These target-date funds will likely function to the best of their ability when they are bought and held over long periods of time with steady contributions.
David Fabian is Managing Partner and Chief Operations Officer of FMD Capital Management. To get more investor insights from FMD Capital, visit their blog.