For One-Stop Shopping, Look for the Target Date
Sunday, March 19, 2006
A growing number of investors are finding convenience and instant diversity in target-date funds, which offer one-stop shopping for retirement savers who don't want to worry about asset allocation and rebalancing.
Fund providers have noticed, and a plethora of offerings have come to market in the past several years; there are now 133 funds from more than 20 companies, according to fund researcher Morningstar Inc., and 94 of those are less than three years old.
"Fund families are rolling these out all the time," said Greg Carlson, an analyst with Morningstar, adding that the proliferation of such a useful product is not such a bad thing. "We'd rather see everyone jumping on this bandwagon than launching hot sector funds."
Morningstar recently broke out target-date funds into their own categories, which will simplify the comparison of these easy-to-use yet relatively complicated vehicles.
Target-date retirement funds are baskets of mutual funds that become more conservative as an investor ages by automatically adjusting their asset allocation from equities to fixed income over time. The "target date" refers to the investor's year of retirement, usually identified in the portfolio's name. For example, a 30-year-old who plans to work for another 35 years might invest in the Fidelity Freedom 2040 fund (FFFFX). Among the newer offerings are 2045 and 2050 funds, which are geared toward retirement savers born from 1980 to 1985.
Target-date funds have become popular choices for employer-sponsored retirement plans, often serving as the default option for workers who are automatically enrolled. They aren't right for everyone, however. If following the market and making trades gives you a charge, you may not appreciate the "set-it-and-forget-it" nature of this stand-alone option. But if you dislike researching mutual funds and would rather leave the hassle of rebalancing your portfolio to professionals, they're a good solution.
"This is for a buy-and-hold person who doesn't want to do that much trading," Carlson said. "They are well suited to beginning investors, and they can be a good first investment. That said, the investor still needs to do a fair amount of due diligence at the outset."
When evaluating target-date funds, the first factor to consider is asset allocation. The split between stocks and bonds can vary significantly, even among funds with the same target date. At the more conservative end of the spectrum are the Vanguard Target Retirement funds, which migrate more quickly into fixed income than their peers. For example, the Vanguard Target Retirement 2025 fund (VTTVX) -- theoretically aimed at a 45-year-old investor -- has 57 percent of its assets in equities, which puts it at odds with the 73 percent stock weighting of the Fidelity Freedom 2025 fund (FFTWX) and the 82 percent stock allocation of the T. Rowe Price Retirement 2025 fund (TRRHX).
Underscoring the difference in approach, at the time of retirement the Vanguard fund will scale its equity stake down to about 30 percent, the Fidelity fund's stock allocation will drop to 45 percent, and the offering from T. Rowe will retain a relatively heavier 55 percent exposure.
Another consideration is cost; the better shops will not overlay any additional management fees beyond what it would cost you to build the portfolio yourself. The cheapest is Vanguard, which stocks its target-date offerings with index funds, charging just over 0.20 percent in annual expenses. Fees on similar offerings from Fidelity and T. Rowe, which include higher-priced actively managed funds, range from 0.58 percent to 0.80 percent. On the load side, fund providers typically stock target-date offerings with institutional shares, which are less expensive, but "12b-1 fees" bear watching.
Because these offerings are "funds of funds," they'll be only as good as their provider, so make sure you're confident in the fund family. Not every company can cover all the bases well. Drilling down in this manner will also reveal other important details, such as the amount of exposure to foreign stocks.
What may be less revealing is the short-term performance figures of these portfolios. Given their changing asset levels and different philosophies, relative performance should be taken with a grain of salt, and trade-offs considered carefully. For example, while Vanguard's index-focused offerings may be left behind in a strong rally, they may provide a smoother ride over the long term.
Of course, none of this is cast in stone; your fund provider may change its strategy as the years go by. Fidelity, which introduced the first target-date funds in 1996, made a number of changes recently following a review of old assumptions about mortality and spending levels.
"It's a 'set-it-and-forget-it' strategy for the shareholder, but not for the investment team," said Jonathan Shelon, co-manager of the Fidelity Freedom funds. "We're constantly challenging ourselves and testing new approaches."
Among other things, Fidelity's research showed the average retiree was likely to live up to three years longer than was thought 10 years ago. A man age 65 may enjoy a 20-year retirement; his spouse may live a few years longer than that. A member of any given couple has a 50 percent chance of living to 92, Shelon said. On top of everything else, in the later years of retirement, spending patterns are difficult to predict.
"Your greatest risk in retirement is what we call longevity risk," Shelon said. "We want to make sure in that late stage, we're helping you preserve your money, and making sure you don't outlast it."
To reflect longer retirements, Fidelity recently increased the rolldown period from majority equities to majority fixed income, from five to 10 years after retirement to 10 to 15 years. In addition, an inflation hedge has been added to some of the portfolios in the form of a fund that invests in Treasury Inflation-Protected Securities.