Are Target Date Funds Worthy of Your Portfolio?

May 21, 2013

target date fundsIf you have looked at your 401(k) investment options recently, chances are you have noticed a list of funds that all have similar names with the exception of a year at the end of each. These “Target Date” funds were built as an all encompassing investment to help you plan for your retirement all in one product. These funds were allocated in a way where you would receive full diversification of both equities and fixed income, with maybe a hint of other diversifiers thrown in the mix. As you get closer to that “target date,” the fund gets more conservative. This sounds great in theory, but are you really getting the best option for your nest egg with this?

All in the Family

The way these mutual funds are built is by using the mutual funds in the fund family arsenal. For example, in a Fidelity Freedom Fund, you will find holdings such as Fidelity Series High Income or Fidelity Advisor Large Cap. Franklin Templeton investors will find items like Franklin Rising Dividends and Templeton Global Bond. You get the bad with the good with these “basket” funds. For every four and five-star fund you have access to, there is a dog that is limping along, dragging down your return.

Apples to Apples?

These funds can be very difficult to compare to each other. Investors in the 35-40 year range who are looking at a retirement age of 70, would look at a target date fund with a 2045. We looked at four different versions of these funds and have found glaring differences. First, in terms of allocation, there was a difference in equities in as much as 10%. The most aggressive was the American Funds version with 84%, of which 30% was international. Franklin Templeton and JP Morgan both came in at 78% with the first one having 28% international exposure and the second 31%. The least aggressive of the four was Fidelity at 74%. Of that, 31% was international.

Looking at the fixed income side of the fund also showed a wide range of differences. While Fidelity had the least amount of equity, it pushed the envelope on the debt side with almost 70% having a credit rating of BBB or lower. Compare that to American Funds with just over 10%.

The expenses of the funds varied as well. Using the A-shares, there was a difference in the Gross Expense Ratio of almost a full percent in these funds. These differences make it very difficult to compare them to each other.

The Payoff?

Ultimately, the big question is do these funds deliver? Take a look at the stats below (as of 4/30/2013):

Chart

 

It may very well be that these target date funds are the only options in your retirement accounts. However, if they are not, you may be best served to look elsewhere for your investing needs. At the very least, look under the hood of these mutual funds and see how they are really doing. There are plenty of free resources out there for you to learn about these funds before you invest in them.

What are your thoughts on target date funds? Leave a comment!

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Victor

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2 Responses to Are Target Date Funds Worthy of Your Portfolio?

  • Roger @ The Chicago Financial Planner

    Nice post. I tend to be more of fan of Target Date Funds for younger investors in a 401(k) or similar plan than for participants say in their 40s or older. For younger participants the longer dated funds are generally a bit on the aggressive side which is good. Additionally they offer an instantly diversified portfolio for these investor where their 401(k) might be their only investment. My daughter who is a 2010 college grad in her first job invests in her plan’s 2055 fund, a good fit for her situation.

    However as investors accumulate some assets and get to mid-career or later a target date portfolio might not be their best bet. They are often better off choosing from among the open funds offered in their plan and also might benefit from some professional advice at this stage of life.

  • Kirk Kinder

    I think target date funds are ok if someone absolutely will not research funds or investments on their own or find an objective, fee-only advisor to guide them.

    Essentially, target date funds are the lazy man’s asset allocation plan which is probably better than what many folks have done previously. I find people put an equal amount in all the funds offered or just get sold a fund by a commission broker/planner. In both of those cases, the target date fund wins.

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