investing

Why Target Date Funds Miss the Mark

Despite the popularity of target date funds, investors should dig deeper when choosing these easy-to-use retirement savings options.

Over the last decade, target date funds have increased in popularity among investors. Target date funds are especially prevalent within 401(k) plans, as they are often promoted to participants as a “set it and forget it” investment solution. According to the Investment Company Institute 2020 Fact Book, nearly $1.5 trillion is now invested in target date funds, the vast majority within 401(k) plans.

For those unfamiliar with target date funds, the fund automatically rebalances the asset mix for a predetermined time frame. Investors typically pick a target date that coincides with their anticipated date of retirement, with the fund reducing equity exposure the closer one gets to retirement. The appeal of target date funds is that they help simplify the complex. The portfolio rebalancing responsibility belongs to the fund manager, with no action required by the investor.  

Most investors would probably expect target date funds with the same target date to have roughly the same asset mix, but our experience shows funds with the same target date can have significantly different asset allocations.

Let’s look at four target date funds with the same target retirement date of 2025 from four large mutual fund companies (all data below is as of 12/31/20):

 T. Rowe Price Retirement 2025 FundVanguard Target Retirement 2025 FundFidelity Managed Retirement 2025 FundDimensional 2025 Target Date Retirement Income Fund
 Ticker: TRRHXTicker: VTTVXTicker: FIXRXTicker: DRIUX
Asset Allocation70% equity / 30% fixed60% equity / 40% fixed47% equity / 53% fixed35% equity / 65% fixed
2020 annual return14.7%13.3%13.1%17.5%

As you can see, the asset allocations vary significantly, even though each fund has the same stated target date.

Here are several takeaways for investors using target date funds:

  • Be sure to look under the hood: Investors should explore the asset allocation of the fund. We prefer target date funds that incorporate international and emerging market equity exposure as well as U.S. equities.  
  • Expenses matter: Expenses are a direct reduction in return; the average target date fund’s expense ratio is 0.62%, according to ICI. Look for funds with expenses below the average. 
  • Don’t be too conservative: The old rule of thumb for asset allocation was subtract your age from 100 and that would be your equity allocation. But consider that for a married 65-year-old couple retiring in 2021, the probability that at least one person will live to age 95 is 50%. The rule of thumb may well be too conservative for maintaining purchasing power over a nearly 30-year retirement period.

Target date funds can be a valuable tool for investors, but remember, even funds that help simplify investing require due diligence and monitoring.

About the Author

Mike Palmer, CFP

Managing Principal, Ark Royal Wealth Management

Mike Palmer has over 25 years of experience helping successful people make smart decisions about money. He is a graduate of the University of North Carolina at Chapel Hill and is a CERTIFIED FINANCIAL PLANNER™ professional. Mr. Palmer is a member of several professional organizations, including the National Association of Personal Financial Advisors (NAPFA) and past member of the TIAA-CREF Board of Advisors.

Most Popular

The Perfect Storm for Retirees
retirement planning

The Perfect Storm for Retirees

Today’s retirees could face a perfect storm because they are living longer and spending more time in retirement, while at the same time losing access …
April 18, 2021
The Wrong Way to Achieve Wealth
personal finance

The Wrong Way to Achieve Wealth

For some down-to-earth, basic advice on money and life, I have a book to recommend: “Your Total Wealth: The Heart and Soul of Financial Literacy.”
April 17, 2021
Child Tax Credit 2021: Who Gets $3,600? Will I Get Monthly Payments? And Other FAQs
Coronavirus and Your Money

Child Tax Credit 2021: Who Gets $3,600? Will I Get Monthly Payments? And Other FAQs

People have lots of questions about the new $3,000 or $3,600 child tax credit and the advance payments that the IRS will send to most families in 2021…
April 14, 2021

Recommended

Is Your Financial Plan Flexible Enough?
retirement planning

Is Your Financial Plan Flexible Enough?

As your life changes, your financial plan may change too. And that’s OK.
April 19, 2021
Wealthy Should Act Now to Prepare for Bernie Sanders’ Estate Tax Proposal
estate planning

Wealthy Should Act Now to Prepare for Bernie Sanders’ Estate Tax Proposal

Anyone with an estate of $3.5 million or more should think about getting in line now to talk to an estate professional, because offices everywhere are…
April 18, 2021
The Perfect Storm for Retirees
retirement planning

The Perfect Storm for Retirees

Today’s retirees could face a perfect storm because they are living longer and spending more time in retirement, while at the same time losing access …
April 18, 2021
4 Ways to Keep Your Taxes Down If You Are Self-Employed
tax exemptions

4 Ways to Keep Your Taxes Down If You Are Self-Employed

Whether you drive for a ride-hailing service on the side or work full-time as your own boss, these tips can help you save money when time comes to pay…
April 17, 2021