Target date funds comparison – Aren’t they all the same?
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Updated: August 15, 2023
Target date funds are a staple in many 401(k) plans. The qualified default investment alternative (QDIA) provision of the Pension Protection Act of 2006 provides 401(k) plan sponsors with protection from any fiduciary liability that might be associated with choosing an investment option, such as a target date fund, for employees who do not make their own election as to where their contributions should be invested. Generally, the plan sponsor will use the target date fund with a target date closest to the employee’s anticipated retirement date.
That’s all well and good, but is that particular option or any target date fund the right choice for your retirement savings? Are target date funds a good choice for investing outside of your company’s retirement plan?
Here are some things to consider before deciding to invest in a target date fund.
Target date funds with the same target date may not be similar
Just because two target date funds have the same target date does not mean their portfolios are the same. In fact, different fund families often have different approaches with their target date funds.
In looking at the percentage of equities held by different families of target date funds, I used the JP Morgan Target Date Compass tool to look at the equity holdings of five target date families at age 65:
Courtesy JP Morgan Funds, information via Morningstar as of March 31, 2016
The John Hancock and Nationwide funds had the lowest and highest allocations to stocks at age 65 of all of the target date fund families tracked by JP Morgan’s Compass tool. The range was widely dispersed across the target date fund universe between these two extremes.
If you are investing outside of your company’s 401(k) plan, you have a lot of choices if target date funds are of interest to you.
Within your 401(k) plan there will generally be one target date family with its range of funds and target dates to choose from.
Fidelity, Vanguard, and T. Rowe price compared
By far the three largest players in the target date funds market are Vanguard, Fidelity and T. Rowe Price, with a combined market share of 70.6% of target date assets at the end of 2015.
Here is a comparison of the asset classes represented in the portfolios of the three largest target date families.
Asset classes represented
Courtesy JP Morgan Funds, information via Morningstar as of March 31, 2016
The investments in these three target date families are all made up of underlying funds from their respective families. In the case of T. Rowe and Vanguard, these are the same funds investors can buy individually. In the case of Fidelity, a number of the underlying mutual funds are separately tickered funds created specifically for use in their target date funds.
Most but not all target date funds are mutual funds of the sponsoring family. It is important you understand the underlying investments used in any target date fund you are considering.
Retirement glide path
One of the key factors touted by target date funds is their glide path into retirement, or in plain English, the age at which their allocation to equities levels out into retirement and presumably until the fund holder dies.
Glide Path Ages of the Three Major Players
Courtesy JP Morgan Funds, information via Morningstar as of March 31, 2016
All three of these fund families extend their glide path into retirement past age 65 or through retirement age. Some other families end their glide path at age 65 and go to retirement. In looking at a target date fund as an investment vehicle into your retirement age, it is important that you research the glide path and understand the potential risks both from being too aggressive into retirement or not aggressive enough. The latter can put you at risk of outliving your assets.
Is the glide path important?
Target date funds are big business for the fund families offering them. From personal experience, I know that participants in 401(k) plans administered by Fidelity receive a lot of encouragement to continue to use their target date funds when they leave their employer and roll their 401(k) plan over to an IRA. I’m sure T. Rowe, Vanguard and other target date fund families do the same thing.
The glide path is important if you invest in a target date fund during retirement. It is important you understand the glide path and when the equity percentage levels off. Is this allocation right for you? If you have other investments, how does this dovetail with your overall portfolio?
For those who will likely roll their 401(k) over to an IRA at retirement and invest their money elsewhere, the glide path is important to you only to the extent that it impacts the fund’s allocation during your pre-retirement years.
Expenses are important
Expenses are an important issue no matter what type of mutual fund you are considering. In looking at target date fund expenses, some are simply a rollup of the weighted average expense ratios of the underlying mutual funds. This is the case with Fidelity, T. Rowe and Vanguard. In other cases, the fund may impose a management fee on top of the underlying mutual fund expenses.
Here are the expense ratios for a sample of the funds offered by Fidelity, T. Rowe and Vanguard:
Source Morningstar.com
Vanguard’s expenses are low due to the use of their low-cost index funds. Fidelity and T. Rowe both primarily use actively managed funds, which carry higher costs.
Note that all three fund families offer different share classes of their target date funds, which will impact the expense ratios. In addition, Fidelity offers a low-cost index version comprised of its index mutual funds.
Is a target date fund right for you?
Like most questions in the realm of investing and financial planning the answer is, “It depends.”
For younger people entering the workforce the appropriate target date fund option in their employer’s 401(k) plan can be a great option. In most cases these newer members of the workforce have few, if any, investments outside of the 401(k) plan, and target date funds can offer a professionally managed, instantly diversified portfolio.
For those a bit farther along in their careers and certainly for those heading into retirement, it may be better to diversify into other investments. These would include investments outside of their 401(k) plan, such as taxable accounts, IRAs and other investment assets.
Two things to keep in mind when considering using target date funds:
- Target date funds are designed to be the only investment one might use. Adding them to a mix of other investments might create an asset allocation that is not appropriate for you.
- You are not limited to any specific target date. You are free to use any fund in the target date series that is most appropriate to your risk tolerance.
Roger Wohlner is an experienced financial advisor, finance blogger and freelance writer based in Arlington Heights, Ill. His expertise includes providing financial planning and investment advice to individual clients, 401(k) plan sponsors, foundations and endowments.
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