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Should Target Date Funds Be Standardized?

This article was written by in Investing. 11 comments.


The Security and Exchange Commission (SEC) is setting up a new division to oversee new financial products, and this group is starting with target date funds. These are mutual funds usually taking the form of baskets of other mutual funds, designed to target a certain year of retirement. As the year approaches, the fund automatically changes asset allocation, usually between stocks and bonds, to become less risky.

I’ve pointed out some of my concerns with target date funds here before. Mainly, they could be too conservative and it’s easy to hide fees. Mary Schapiro, the head of the SEC, pointed to the exchanges from stocks to bonds. The cost of the sales and purchases is buried in the daily price of the target date fund, and there is currently no good way for customers to understand how much they are being charged for the re-balancing of the portfolio they could do on their own.

Schapiro also noted that there is no standard across companies. A target date fund designed for those who plan to retire in 2050 with one fund manager may have a different allocation between stocks and bonds than a 2050 target date fund with another fund manager.

Here is a comparison of the asset allocations for the funds designed for those retiring in 2050 from Vanguard, Fidelity, and T. Rowe Price.

Vanguard Fidelity T. Rowe Price
Domestic Stocks 72.0% 69.5% 67.2%
Foreign Stocks 18.0% 20.0% 22.9%
Bonds 10.0% 10.4% 7.2%
Other 0.0% 0.1% 2.7%

The variation seems small but could have an significant effect on returns by retirement in 2050. If target retirement funds were standardized across companies, customers could accurately and easily compare returns between fund managers, understand the level of risk, and have the opportunity to make better investment decisions.

I am not convinced there is a need for this. Any fund’s composition is described in detail in the prospectus and in on a multitude of financial data websites like Yahoo Finance and Google Finance. What isn’t clear are the true fees. We do know that Vanguard’s fee for their 2050 fund is 0.19%, Fidelity’s is 0.82%, and T. Rowe Price’s is 0.79%, but that only tells part of the story. Whenever there is turnover — stocks are sold and other stocks, bonds, or other investments are purchases — fees are generated but wrapped tightly into the daily price of the fund so it is barely noticeable.

Asset re-allocation is the purpose of target date funds. Even if the underlying funds, those in the basket, are low-turnover index funds, the managers may be rearranging the index funds in the basket often. For those disciplined to handle the responsibility of occasional re-balancing themselves, and it’s not that difficult, I suggest avoiding target date funds.

Target date funds have lots of fans because it’s a form of automation, and automation in finances is usually a good thing. There is a danger of automation leading to complacency and a false sense of security. If you choose target date funds, familiarize yourself with the details and evaluate whether the pre-packaged re-allocation system is worth the thousands of dollars or more you could be losing in hidden fees and with a risk profile that doesn’t match your income needs and tolerance.

Would you like to see target date funds standardizes so a “2050 Fund” from one company matches a “2050 Fund” from another company? or should companies be left to determine what strategy is best for their customers?

Photo credit: viZZZual.com
‘Target Date’ Funds Get Senate Scrutiny, Daisy Maxey, Wall Street Journal, October 30, 2009
SEC to look at retirement investing risks, Marketplace, November 3, 2009

Updated January 16, 2010 and originally published November 4, 2009. If you enjoyed this article, subscribe to the RSS feed or receive daily emails. Follow @ConsumerismComm on Twitter and visit our Facebook page for more updates.

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About the author

Luke Landes, also known as Flexo, is the founder of Consumerism Commentary. He has been blogging and writing for the internet since 1995 and has been building online communities since 1991. Find out more about him and follow Luke Landes on Twitter. View all articles by .

{ 8 comments… read them below or add one }

avatar tom

I'm torn…

As an independent investor, I don't think they should be standardized. Some people might be more comfortable with the 72% domestic stock as opposed to 67.2%.

As an investor in a 401(k), where the target funds are managed specifically for my company and I have little insight into their investments other than what's provided on their fact sheet, I would like to see them standardized.

I invest in Vanguard's 2050 fund because it has low fees, is very straight forward, and I have enough invested to cover the minimum investment amount.

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avatar Financial Samurai

Nope. Then where's the marketing edge? You know the answer.

If everything is the same, everybody will just go to the one with the biggest headstart, and the fund will grow too big and keel over.

FS

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avatar BrianScheur

I am usually all for making things simpler and clearer for consumers, but i think this is unnecessary from the SEC side of things. Anyone that is investing money into the market should take enough of an interest in their finances to understand what type of products they are putting their money into.

Additionally I feel that institutions offering different asset allocations with their funds leads to greater competition. And in the end, it is the individual that needs to take responsibility for where they put their money and the expectations they hold for how it will grow in the future.

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avatar Steve

I too am against standardization. Consumers should be allowed to choose what allocation they want. I am in favor of target funds in general, as my case study of 1 (myself) has clearly shown that consumers do not rebalance often enough. I am in favor of clearly disclosed fees, however.

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avatar kenyantykoon

they must not be standardised because a company will have no edge over others. standardization will in some ways reduce returns because there are some areas that mutual funds will not be allowed to invest in. i am definitely for companies deciding what is best for their customers

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avatar Evan

I dislike the standardization idea because different fund managers will have different ideas what allocation should be at what age..

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avatar freeby50

I do not think the asset distributions should be standardized.

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avatar Michael Harr @ TodayForward

Standardization is a horribly bad idea. There must be some mechanism for fund companies to differentiate themselves AND each investment company has a different slant in their overall styles which impact risk/return profiles. For example, Fidelity as an investment house slants toward the growth side of things, Vanguard is a blend, and Franklin Templeton is more towards value. If you standardize between cash/stocks/bonds, are you also going to standardize between growth/blend/value? How about short/intermediate/long-term bonds? Foreign and domestic? Truly horrible idea.

Also, I'd say that the allocations are almost uniformly too aggressive in these funds. Savvy/seasoned/smart/choose and adjective investors will not go with target date funds because with few exceptions, fund companies stuff laggard funds inside of these funds-of-funds. This means that those holding these funds are more likely to be less educated in the area of investing and will generally be less able to deal with market volatility. In recognizing this, fund companies should lean towards the conservative end of the spectrum with their equities allocations. Yes, there is some return given up, but if investors get burned too badly with a market decline, they may exit equities altogether. Generally speaking, it's a far better thing to capture 70% of the market return and stay invested than to get 100% of the market return only to exit at the worst time (which is the norm for ill informed investors).

I'm not saying that people can't get educated about these things, but if you consider prior to the Pension Protection Act of 2006 that 401k participants favorite investments were (1) cash, (2) company stock, and (3) bonds, it's pretty clear that most of those buying these funds could use a little help…preferably from the fund companies and not the SEC.

By the way, doesn't the SEC have bigger fish to fry? How about the dark markets of derivatives and private securities? Isn't that kind of what got us into the Great Recession?

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