Target-date funds are relative newcomers in the investment world. Most of today’s target-date funds were created in the last 10 years or so. Their popularity has grown largely since the passage in 2006 of the Pension Protection Act.
The Pension Protection Act stipulates that employers provide what are called “Qualified Default Investment Alternatives” which is a fancy way of saying that they need to provide default investment alternatives that don’t suck. And target-date funds are generally considered to not suck.
Typical Target-Date Fund
The general idea of the target-date fund is to invest for growth when the investor is young and gradually decrease the amount of risky investments as the investor approaches retirement age. Typically the risky investment takes the form of stocks and the safer investment is in bonds.
The transition from the early growth period to the later safe period is called the “glide-path”. In visual form, here’s what a typical glide path looks like.
This plot shows the glide-path continuing to decrease a little past the retirement age. This is fairly common and is often referred to as a “glide-through” fund versus a fund that stops changing right at the target-date which is called a “glide-to” fund. It’s good to understand these differences so that you aren’t surprised to find that your fund is still changing allocation after the target-date.
For the purposes of this article, I was focused on some of the more popular target-date funds. Defining popularity is tricky so I chose to just consider the biggest and cheapest funds. “Biggest” funds are defined by their assets under management, and “cheapest” funds are defined by their expense ratios. The data for this article came mostly from a comprehensive article published by Morningstar titled “2015 Target-Date Fund Landscape”, and was verified by looking at the individual mutual-fund companies’ websites.
Biggest Target-Date Funds
The following table lists the 4 biggest target-date funds in terms of total market share:
|Fund Family||2014 Market Share (%)||Expense Ratio (%)|
These four funds make up wholly two thirds of all target-date funds so they are the gorillas. Vanguard is the clear market share leader with over a quarter of the entire target-date fund market. But Fidelity has a couple of entries that add up to over 20% of the market. From what I’ve been able to glean, Fidelity’s “K” series of funds is similar to the non-K series except that it is only available to 401k plans run by Fidelity.
Cheapest Target-Date Funds
And here are the 4 funds with the smallest expense ratios:
|Fund Family||2014 Market Share (%)||Expense Ratio (%)|
Not surprisingly, the low-cost leader Vanguard is also on this list. But the “Fidelity Freedom Index” fund has a slight edge on expense. Note that the “Fidelity Freedom Index” is yet another target-date fund from Fidelity. The “Index” variant from Fidelity appears to be their low-cost variant composed of only low-cost Fidelity index funds. The “Index” variant is also only available via certain employer-sponsored plans which is why you can’t easily find information about them on their public website.
Here are the glide paths for all of the funds mentioned above1. The zero point on the time axis represents the relative target date. For example, the point -10 for a 2040 fund maps to the year 2030.
Of these 7 funds, only BlackRock is the only “glide-to” fund that stops changing its allocation right at the target date. BlackRock is also unique in that its equity percentage contains a fair amount of real-estate (REIT) investments (15% early on, dwindling to near 0% at the end of the glide path). I decided to lump the REIT into the “equity” bucket for this graph but some would argue that you should put a portion of it into the “bond” bucket.
All funds except BlackRock start at 90% equities. If I had allocated 1/3 of the REIT to equities then BlackRock would also have close to a 90% equity position at the beginning too so consider that when looking at the graph.
Most funds have finished their glide paths within 7 years but T. Rowe Price continues the glide down for 30 years.
Plotting the different glide paths is an interesting exercise and tool for comparing funds to see which one most closely aligns with your goals. But you don’t have to pick the fund that matches your exact retirement date. For example, if you want the glide path to stop right at your retirement date and you like Vanguard, then you might want to pick the Vanguard fund that is your retirement date minus 7 years to line that up with your goals.
I think that most of these funds end at a very “safe” level of equities, perhaps too safe for my tastes, but maybe just right for you. I suspect that the fund companies err on the side of being too conservative to avoid controversy. As such, my preference would be to use a target date fund mostly during your accumulation years then switch to a balanced fund (or set of funds) that match your long-term risk tolerance when you are near your target.
One thing, a big thing, that these funds can’t account for is how much money you have in a pension or social security. For example, if your social security will cover 50% of your future spending, do you really need the rest of your portfolio to glide to a 30% equity level? You may conclude that you can take more risk in your portfolio when social security has your back. In the end, it comes down to your personal situation and your comfort level with risk.
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