Not All Target Retirement Funds Are Created Equal
Over the last few years, “target” retirement funds have become more popular. Vanguard offers a wide selection for those looking to retire between 2005 and 2050 in 5-year increments. Fidelity offers the same options with their “Freedom Funds.”
One would think that the Fidelity Freedom 2020 Fund should be similar to the Vanguard Target Retirement Fund 2020 in terms of asset allocation and risk exposure. They don’t. Each company has its own interpretation of what asset allocation is appropriate. The form of these all-inclusive retirement funds is that the allocations change over time, and funds from different companies will see variations in the timing of these adjustments.
While Vanguard and Fidelity are two of the lower-cost funds, fees vary from company to company. Since target retirement funds are mutual funds containing investments of other mutual funds, not only do you have to deal with the fees of the underlying investments, but sometimes there will be added fees to represent the convenience of having the all-in-one fund.
USA Today has a recent article discussing these target retirement funds. The author suggests identifying these aspects of retirement funds before making any investments.
1. The glide path. How quickly a fund moves from stocks to bonds is called its glide path. Just how the fund family arrives at the glide path is a mixture of mathematics and philosophy. Putnam’s RetirementReady funds, for example, use a mathematical formula to determine their glide paths. The formula considers a person’s earning power and financial assets as two parts of one portfolio.
2. The underlying investments. For example, the Hartford Target Retirement 2020 fund has an 18% stake in Hartford Capital Appreciation, a top-performing large-company stock fund.
On the other hand, the fund also has 4.6% of its assets in Hartford International Opportunities, which has lagged behind 75% of its peers over the past five years, according to Morningstar, the mutual fund trackers.
3. Expenses. If you buy from a broker, A shares will cost you less in the long run than B or C shares. A shares charge an upfront sales charge, or load. B and C shares have no upfront sales charge, but they have higher ongoing expenses. For example, suppose you wanted to invest $100,000 in the John Hancock Lifecycle 2025 fund.
4. More than one. Finally, you might not want to entrust your entire retirement plan to just one target fund, no matter how diversified it is. A truly well-rounded retirement portfolio would mean owning at least two target funds Ã¢â‚¬â€? just to be sure.
The article contains an informative comparison chart. The chart provides important details about funds that target retirement in 2020 provided by Vanguard and Fidelity, as I mentioned earlier, as well as several other companies. There are a wide range of investment possibilities. Some investors may be willing to accept slightly higher fees in return for not having to change your asset allocation manually, but it’s still important to see the difference between the offerings.
Personally, I’ll continue to manage my own asset allocation.
Target-date funds are well and good, but most people do not use them correctly. If you use a target-date fund, that fund should be your entire retirment portfolio. If you want to “set it and forget it” target-dates are good–and if you use them correctly.
I think these lifecycle funds are a good concept for those who want to do something but do not otherwise have a strong interest in managing their investments. Similar to the author, I prefer to manage my own investments over putting them into a fund such as this for the following reasons:
Asset Allocation – while lifecycle fund mixes generally follow a good rule of thumb, it may not really align with the individual investors own philosophy. For example, if one wanted to be somewhat over / underweighted in a certain class of investments.
Expenses – Lifecycle funds do not seem to be the “no brainer” in terms of expenses either. In fact, many of them are just a “bundle” of other funds from the same investment firm where you get a small break in the expense. I think I can do almost equally well (if not better), by creating my own mix
As I said, I am not against these type of funds. Like anything else, they are probably a good vehicle for someone…just not for me.
I have one of these funds via T. Rowe and I like it. It currently comprises 25% of my retirement assets. Many of the funds that it’s comprised of have good long term track records and the fund overall has a low turnover. The fund itself is only years old but has averaged 12% over the past two years.
On the other hand, a two-year average of 12% is no big whoop when you look at how the market overall has done over that time frame. And while it compromises 25% of my portfolio, that number will decrease over time, and decrease us gonna start sooner than later. My portfolio is a tad light in both the Large Growth and Small Cap sectors so I’ll be focusing on that for the rest of the year. In the end though, I’ll probably park some cash into this fund via a non-tax advantage account.
So yeah, these target funds are good, but definitely know what funds make them up and definitely do NOT make 100% of your whole investment. Just my .02.