Target Date Funds With the Same Target Date May Not Be Similar
For The Following Reasons:
Handling Fees …Each fund charges a 1% fee.
Asset Allocation …Some funds may be more conservative while others may be more aggressive.
Investment Grade Bonds …If a fund has more bonds than the other in the portfolio, the fund will generally perform more under adverse conditions—market downturns, for example.
New Issues Choices …No fund allocates all new issues to the same stock-bond ratio.
Filtering …Selective funds may avoid stocks that the index includes.
Cash …Some funds can invest a portion of assets in cash to reduce risk.
Indexes are divested of investments.
Backloading …Typically, stock funds have less stable allocations in the early years of the target date.
Fidelity, Vanguard, and T. Rowe Price Compared
Cap-weighted Index Versus Risk-adjusted Over Time
History tells us that past performance does not accurately predict future results. However, the recent performance of the T. Rowe Price era returns have been much worse than expected. Where is the out-performance to T. Rowe Price? Are they taking the same risk? Or are they underperforming?
I reviewed three funds that have been established for over 20-years = T. Rowe Price Retirement 2045 Fund (TRRKX), Vanguard 500 (VFIAX), Fidelity Freedom 1750 Fund (FFKLX) and compared them in three categories.
The first category is price trends, shown above. The price for the T. Rowe Price Fund increased by only 0.1% per year for the last three years. The Vanguard 500 gained 2.7% per year and the Fidelity Freedom 500 gained 2.4% per year. The Fidelity Freedom index gain was more than two times greater than TRRKX index gains. Price trends is called a leading indicator. (FFKLX chart also started in 1990, like TRRKX.)
How did the funds work in combination with a simple and basic buy-and-hold strategy?
Asset Classes Represented
There is a bewildering variety of target date funds (TDFs). All these TDFs will start with a date like 20XX, and apply asset allocation through time. The biggest component of that is usually equities (stocks). The equity component will be divided among the following target date fund asset allocation – categories:
- US stocks
- International stocks
- Emerging market stocks
- Real estate
Other target date funds will add in other equity categories like small and mid-cap stocks. Whatever is in the youngest target date fund, that will be the equity mix for the entire life of the portfolio. So for example, if you have a target date fund for a 45 year old, the portfolio will be primarily equity-focused, with a larger allocation to US stocks & international stocks than the other equity categories.
Retirement Glide Path
A glide path is a portfolio strategy created by an advisor who has gotten you to the retirement date with a mix of stocks, bonds, and cash. It is usually dictated by a series of rules and adjustments to keep the portfolio on course and to minimize losses.
For instance, a steady glide path follows a pre-defined percentage over time. This could be, for example, 70% stocks and 30% bonds over the first 10 years of retirement, 60% stocks and 40% bonds over the next 10 years, followed by 50% stocks and 50% bonds for the remainder of the time before you retire.
A stepped or stepped-up glide path is a ramp-up on a steady glide path. It calls for a higher initial percentage in stocks, which can help to protect against a bear market if and when it eventually takes place.
However, bear markets can be very scary when you are drawing down your account holdings. Thus, many advisors use a steady glide path for clients who are using a fixed amount of funds.
Is the Glide Path Important?
Most Target Date Funds will have a glide path. This is the curve the fund follows over the years that it becomes more conservative. This takes it off the stock market and into the less risky fixed income asset classes.
Generally it starts around 8% stocks in the first year and perhaps hovers around 12% stocks for a few years before gradually increasing to 40% stocks by year 10. This is only a general guide and some funds may do it faster or slower.
The distributions will change to match the amount of stocks. The default, which tends to be the most common, is to decrease the stock percentage distribution 1% a year. Then in year 20, there are no distributions until retirement and the year 20% distribution is paid.
The chart below shows the change in distribution over a typical glide path. The gray bars represent the initial years and go up to the 20th year. The green line is the year by year increase over the years.
The general idea is that you save in the investment years for your early retirement years. The most important number to look at when researching a Canadian Target Date Fund is the year it hits 20 years. That is when the distributions will level off.
Expenses Are Important
As a financial planner I have a different view of Funds than most people. To me they are instruments to help you reach your financial goals. They are ways to create diversity in what you own and how you invest your money.
In our opinion the following statements are invalid:
An index fund is a better investment than any managed mutual fund.
2 Expense ratios are a measure of a fund’s performance.
3 It is possible to identify a fund by looking at its past performance.
Our current view is that your money is best invested through target date funds. They make it easy to invest in a diversified portfolio of stocks, bonds and cash without picking through individual funds.
What is a target date fund?
Target date funds are intermediate term mutual funds that hold a mix of stocks, bonds and cash. They’re intended to be relatively asset-allocated to stocks, bonds and cash over time, and the mix changes with your age as a concession to your declining capability to take risks.
Since target date funds are mutual funds, they have a management expense ratio, or MER, a fixed amount paid annually to cover the cost of management. The key to target date funds is that the fund manager automatically, over time, adjusts your investments as you approach your retirement date.
Is a Target Date Fund Right for You?
Choosing a retirement plan for your IRA account is an important decision and should not be made without careful consideration. The first thing you need to decide is if a target date fund will work for you.
A target date fund is a mutual fund—that’s becoming more and more popular for people setting up IRA accounts—that is designed to be a one-stop-shopping choice for an investor’s retirement account.
Basically, a target date fund has a date attached to it. When you choose a target date fund, you are signaling your preference for the type of holdings you want in your retirement account. The manager of the target date fund then allocates your investment to other funds based on your stated retirement date (hence the name).
While it’s understandable that you might want to use a target date fund to manage your retirement investments, let’s take a closer look at whether it’s truly a good fit for you.