Target date funds have the been the flavor of the year–for the past few years-when it comes to 401(k) and other retirement plan investing. However, it’s important to remember that popularity and quality are often two different things, and investment products are no different.
Even though target date funds have become popular, it’s worth asking whether they’re truly good investment vehicles.
What is a Target Date Fund?
Target date funds are mutual funds where the portfolio’s asset mix (stocks, bonds, cash) is automatically reset according to a selected time frame. Target date funds are designed to address some future date, usually retirement. They are structured to get more conservative by decreasing their exposure to stocks and increasing their exposure to bonds as people get closer to their target year.
Target date funds are popular with 401(k) plan investors because they are convenient and easy. The investor simply makes one choice–a specific target date fund–and then can (though not desirable) let the retirement plan run on autopilot.
Another reason for their popularity is that thanks to the Pension Protection Act of 2006, target date funds are one of the few permissible “default options” for retirement plans with an automatic enrollment feature.
Target Date Funds Comparison
Key Factors
When choosing the right target date fund for you, there are several key factors to keep in mind:
1. Target Date Year
Just because you plan on retiring somewhere between, say, 2021 and 2025, does not automatically mean that a 2021-2025 target date fund is the right fund for you.
Target date funds, in general, have been criticized for having stock allocations that are too high. If you agree, and want to your portfolio to be more conservative, you can simply choose a target date earlier than the date in which you plan to retire.
2. Target Date Fund Family
If you’re investing in a 401(k) or other work-sponsored retirement plan, you’re going to be limited to the fund families your employer has chosen to be included in the plan.
Hopefully, you have several choices of fund families. If you do, you’ll need to do a target date funds comparison of factors such as fees, investing strategy, risk level, past performance and manager experience, among others. These can all vary considerably. Look to Morningstar, a well-respected mutual fund rating agency, and other sources to help you with your comparison.
The best fund families, as chosen by Target Date Analytics and Money Magazine, are listed in the “Best Target Date Funds” section below.
3. Target Date Fund Type: “To” Vs. “Through” Retirement
This is a key, but often overlooked, factor when comparing target date funds. The bottom line is that “to” funds generally will be more conservative than “through” funds.
“To” retirement funds reach their most conservative stock allocation at the target date, while “through” funds reach their final stock allocation after retirement.
Most funds are “through” retirement funds, and reach their lowest stock allocation up to 15 or more years after the target date. These funds are structured to protect investors from longevity risk, and may be a good choice if you come from a family where people tend to live long lives.
However, the drawback is that a stock market downturn soon before retirement will likely result in greater losses, when you can least afford them, than those sustained in a “to” retirement fund.
U.S. News Target Date Funds Rankings
U.S. News has assigned mutual fund scores to mutual funds of all types, including target date funds. The scoring (0-100) is based on ratings from Morningstar, Lipper, Zacks, TheStreet.com, and Standard & Poor’s.
For one example, a comparison of 40 Target Date 2021-2025 Funds resulted in these three funds scoring the highest:
T. Rowe Price Retirement 2025 Fund (TRRHX)
Score: 8.0
Performance (1-YR): 2.06%
Expense Ratio: 0.72%
Vanguard Target Retirement 2025 Fund (VTTVX)
Score: 7.9
Performance (1-YR): 0.37%
Expense Ratio: 0.18%
TIAA-CREF Lifecycle 2025 Retirement Fund (TCLFX)
Score: 7.3
Performance (1-YR): 1.56%
Expense Ratio: 0.68%
For another example, the U.S. News comparison of 37 Target Date 2041-2045 Funds resulted in these three funds scoring the highest:
T. Rowe Price Retirement 2045 Fund (TRRKX)
Score: 8.0
Performance (1-YR): 3.47%
Expense Ratio: 0.76%
Vanguard Target Retirement 2045 Fund (VTIVX)
Score: 7.3
Performance (1-YR): 2.51%
Expense Ratio: 0.19%
Wells Fargo Advantage DJ Target 2045 Fund (WFQPX)
Score: 7.0
Performance (1-YR): 4.06%
Expense Ratio: 0.52%
(Data as of Jan. 6, 2012)
Best Target Date Funds
Best Target Date Funds: Target Date Analytics
Target Date Analytics recently analyzed and graded 48 target date funds. The grading (A through F) is based on investment strategy, performance, fees, risk factors and company organization. Only offerings with at least a 3-year history were eligible for grading.
The following offerings (listed alphabetically) earned a top grade of “A:”
- American Century Live Strong
- JP Morgan Smart Retirement
- MFS Lifetime
- Vanguard Target Retirement
- Wells Fargo Advantage Dow Jones
Best Target Date Funds: Money Magazine
Money Magazine’s “Money 70″ ranked the best mutual funds and exchange-traded funds (ETFs) in various categories. It chose two funds in the Target Date Retirement category:
- T. Rowe Price Retirement
- Vanguard Target Retirement
Target date funds are definitely not the optimal way to go when choosing and managing your 401(k) or other retirement savings, in my opinion.
However, if you’re someone who doesn’t have the knowledge and/or desire to regularly (or just annually) review and rebalance your retirement portfolio, target date funds can be an adequate, or even good, choice.
That said, serious thought still needs to be put into your initial decision to choose a specific target date fund.
Best of luck in keeping your retirement savings on target!
