Objective information about financial planning, investments, and retirement plans

Target Date Funds: Does the Glide Path Matter?

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Most Target Date Funds are funds of the mutual funds of the fund family offering the TDF.  The pitch is to invest in the fund with a target date closest to your projected retirement date and “… we’ll do the rest….”  A key element of Target Date Funds is their Glide Path into retirement.  Stated another way the Glide Path is the gradual decline in the allocation to equities into and during retirement.  Should the fund’s Glide Path matter to you as an investor?

Glide PathTarget Date Funds have become a big part of the 401(k) landscape with many plans offering TDFs as an option for participants who don’t want to make their own investment choices.  Target Date Funds have also grown in popularity since the Pension Protection Act of 2006 included TDFs as a safe harbor option for plan sponsors to use for participants who do not make an investment election for their salary deferrals and/or any company match.

These funds are big business for the likes of Vanguard, Fidelity, and T. Rowe Price who control somewhere around 70% of the assets in these funds.  Major fund families such as Blackrock, JP Morgan Funds, and the American Funds also offer a full menu of these funds.  Ideally for the fund company you will leave you money in a TDF with them when you retire or leave your employer, either in the plan or via a rollover to an IRA.

What is a Glide Path?

The allocation of the fund to equities will gradually decrease over time.  For example Vanguard’s 2060 Target Date Fund had an equity allocation of almost 88% at the end of 2013.  By contrast the 2015 fund had an equity allocation of approximately 52%.

This gradual decrease continues through retirement for many TDF families including the “Big 3” until the equity allocation levels out conceivably until the shareholder’s death.  T. Rowe Price has traditionally had one of the longest Glide Paths with equities not leveling out until the investor is past 80.  The Fidelity and Vanguard funds level out earlier, though past age 65.

There are some TDF families where the glide path levels out at retirement and there is some debate in the industry whether “To” or “Through” retirement is the better strategy for a fund’s Glide Path.

Should you care about the Glide Path? 

The fund families offering Target Date Funds put a lot of research into their Glide Paths and make it a selling point for the funds.  The slope of the Glide Path influences the asset allocation throughout the target date years of an investor’s retirement accumulation years.  The real issue is whether the post-retirement Glide Path is right for you as an investor.

On the one hand if you might be inclined to use your Target Date Fund as an investment vehicle into retirement, as the mutual fund companies hope, then this is a critical issue for you.

On the other hand if you would be inclined to roll your 401(k) account over to either an IRA or a new employer’s retirement plan upon leaving your company then the Glide Path really doesn’t make a whole lot of difference to you as an investor in my opinion.

In either case investing in a Target Date Fund whether you are a 401(k) participant saving for retirement or a retiree is the ultimate “one size fits all” investment.  In the case of the Glide Path this is completely true.  If you feel that the Glide Path of a given Target Date Fund is in synch with your investment needs and risk tolerance into retirement then it might be the way to go for you.

Conversely many people have a number of investment accounts and vehicles as they head into retirement.  Besides their 401(k) there might be a spouse’s 401(k), other retirement accounts including IRAs, taxable investments, annuities, an interest in a business, real estate, and others.

In short, Target Date Funds are a growing part of the 401(k) landscape and I’m guessing a profitable way for mutual fund companies to gather assets.  They also represent a potentially sound alternative for investors looking for a professionally managed investment vehicle.  The Glide Path is a key element in the efforts to keep these investors in the Target Date Fund potentially for life.  Before going this route make sure you understand how the TDF invests, the length and slope of the Glide Path, the fund’s underlying expenses, and overall how the fund’s investments fit with everything else you may doing to plan for and manage a comfortable retirement.

Please contact me at 847-506-9827 for a complimentary 30-minute consultation to discuss your 401(k) plan and all of your investing and financial planning questions. Check out our Financial Planning and Investment Advice for Individuals page to learn more about our services. 

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Target Date Funds: 6 Considerations Before Investing

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Target Date Funds are a staple of many 401(k) plans. Most Target Date Funds are funds of mutual funds. The three largest firms in the TDF space are Fidelity, T. Rowe Price, and Vanguard with a combined market share of about 80 percent. All three firms use only their own funds as the underlying investments in their target-date fund offerings. Some other firms offer other formats, such as funds of exchange-traded funds, but the fund of mutual funds is still the most common structure.

Here are 6 considerations to think about when deciding whether to use the Target Date Fund option in your company’s retirement savings plan:

Is the Glide Path really that important?

Much has been made of whether the Glide Path (a leveling of the fund’s equity allocation into retirement) should take investors to or through retirement. Target Date Fund providers spend a lot of time devising and administering the Glide Path that their funds use into and through your retirement years.   Before making too much of this, however, the key question is what will you do with your retirement plan dollars once you retire? TDF providers hope that you take the money invested in their Target Date Funds and roll these dollars into an IRA with them, maintaining your Target Date Fund position.  There are big dollars at stake for them.  In reality you might take your money out of the plan and do something else with it, including consolidating these funds with other retirement assets already in an IRA perhaps at another custodian.

How does the allocation of the Target Date Fund fit with your other investments? 

Many 401(k) participants invest their retirement dollars in a vacuum—meaning they don’t take their investments outside of the plan into consideration when making their investment choices. This is fine for younger workers just starting out.  Their 401(k) investment might be their only investment and the instant diversification of a Target Date Fund is fine here.

For those with other outside investments such as taxable accounts, a spouse’s retirement plan, and perhaps an IRA rolled over from old 401(k)s, this is a big mistake. Given that TDFs are funds of funds you might become over or under allocated in one or more areas and not know it as your account grows. Factoring the Target Date Fund allocation into your overall portfolio is critical. 

Is the Target Date Fund closest to your projected retirement date the right choice for you?

For example, a 2020 Target Date Fund is conceivably meant for someone who is 58 and retiring in seven years. If you were to take three 58-year-olds and look at their respective financial situations and tolerance for risk, it is likely that they are all fairly different. Plan providers need to do a better job of communicating to plan participants that the fund with the date closest to their projected retirement date may not be the right fund for their needs. Look at your own unique situation and pick the TDF that best fits your needs. 

Understand the underlying expenses

In some cases, the overall expense ratio may be a weighted average of the underlying funds. Others may also tack on a management fee to cover the costs of managing the fund. As with any investment, understand what you are being charged and what you are getting for your money. 

Target Date Funds don’t equate to low risk

Many participants are under the mistaken impression that investing in a Target Date Fund is a low risk proposition. As we saw in 2008, nothing could be further from the truth. Many investors in 2010 funds saw losses in excess of 20 percent. A recent review of more than 40 Target Date Fund families showed the share of stocks in the funds designed for those retiring in the current year ranged from about 25 percent to about 75 percent. As with any mutual fund, look under the hood and understand the level of risk that you will be assuming.

Investing in Target Date Funds doesn’t guarantee retirement success 

Contrary to the belief of some, investing in a Target Date Fund doesn’t guarantee that you will have enough saved at retirement.  Building a sufficient retirement nest egg is all about how much you save and how you invest those savings.  Target Date Funds may or may not be the best investment vehicle for your needs.

Target Date Funds can be a good vehicle for 401(k) participants and others who are not comfortable allocating their own investments. Unfortunately, TDFs are not a set it and forget it proposition. Investing in Target Date Funds requires periodic review to ensure that the fund you have chosen is still right for your situation. Retirement plan providers and sponsors also need to do a better job of communicating the benefits, pitfalls, and potential uses of these funds to plan participants.

Please feel free to contact me with questions about 401(k) investment options or about your overall financial and retirement planning needs.  Check out our Financial Planning and Investment Advice for Individuals page for more information about our services.  

For you do-it-yourselfers, check out Morningstar.com to analyze your Target Date Fund and all 401(k) investment options and to get a free trial for their premium services.  Please check out our Resources page for links to some additional tools and services that might be beneficial to you.  

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T. Rowe Price Target Date Funds – A Look Under The Hood

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This is another in a series of posts on Target Date Funds that I’ve written for this blog.  As both a financial planner for individual clients and an advisor to several 401(k) plans I have mixed feelings about them.  TDFs offer investors a professionally managed all-in-one investment solution.  Ideally you invest in the fund with a target date closest to your anticipated retirement date and the fund does the rest.

Personally I like TDFs more for younger investors versus those who are within say 15 years or so of retirement.  Target Date Funds have become a staple in 401(k) plans due to the safe harbor given to plan sponsors who use them as the default investment choice for those plan participants who do not make an election of their own.

Fidelity, T. Rowe Price, and Vanguard control about 80% of the assets in Target Date Funds.

Recently mutual fund ranking service Morningstar revamped its ranking methodology for Target Date Fund families.  They moved to the Gold, Silver, and Bronze rankings they implemented for mutual funds in 2012.  For the period ending December 31, 2012, only T. Rowe Price and Vanguard received the top Gold ranking.  Fidelity was ranked as Neutral.

Let’s take a look under the hood at the T. Rowe Price Target Date Funds.  T. Rowe offers funds with target dates beginning in 2005 and going out to 2055 in five year increments.  Additionally they offer an Income version of the fund for those already in retirement.

Active Management

T. Rowe uses mutual funds from its line-up of funds that are available to the public.  The underlying funds are almost exclusively actively managed in contrast to Vanguard’s use of its passive index funds.  The overall expense ratio of the funds is a weighted rollup of the underlying funds and currently ranges from 0.57% for the Retirement Income fund to 0.78% for the most aggressive fund, the Target 2055.  This is more expensive than Vanguard but all of the T. Rowe funds rank in the top quartile (less expensive) of their respective Morningstar categories. 

Solid Underlying Funds

Each of the 12 T. Rowe Price Target Date Funds received a ranking in the top quartile (the top 25%) of their respective Target Date categories, with 6 of the funds earning the top ranking or “0” from FI360 an outside service that ranks mutual funds and ETFs based upon 11 criteria.

Further, of the 19 underlying funds used across this target date series 17 had enough history to receive a 5 year Lipper ranking and 12 of those funds ranked in Lipper’s top quartile for the 5 years ended December 31, 2012.  This is a higher percentage than either Fidelity or Vanguard. 

Glide Path and Asset Classes

T. Rowe Price uses 12 asset classes in its TDFs; Vanguard uses 7; Fidelity uses 11.  This is not good or bad, but does reflect the broader approach employed by T. Rowe Price.  Note since the end of the year, Vanguard has added some funds in the fixed income area as well as some other tweaks.

T. Rowe Price’s Glide Path levels off at age 95 making it among the most aggressive of the target date fund families available.  By contrast Vanguard’s Glide Path levels off at age 72; Fidelity’s at age 80.  The Glide Path is the leveling off of the equity allocation of the fund as the investor moves into retirement and assumes that the investor will hold the fund until death; this may or may not be the case in reality.

Are Target Date Funds the Right Answer? 

As mentioned above, I have mixed feelings.  On the one hand TDFs are often a better solution than simply letting one’s retirement plan assets languish in a money market account.  On the other hand I am convinced that investors who are either comfortable doing their own allocation or who utilize an advisor are generally better served by tailoring an allocation from among the menu of investment choices offered in their 401(k) plan.

While I tend to favor Vanguard’s low cost passive approach, T. Rowe Price does an excellent job as well.  They have stuck to their knitting through the years and provide a solid option in the Target Date Fund space.

Check out Morningstar.com to look under the hood of T. Rowe’s Target Date Funds and to compare them against other alternatives that you might be considering.  Get a free trial for their premium services.

Please feel free to contact me with questions regarding your investments and your retirement planning issues.

 

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Target Date Funds Don’t Guarantee Retirement Success

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A recent article in the Wall Street Journal professional edition was entitled “Target” Funds Still Missing the Mark. The premise of the article was that Target Date Funds were falling short in their investment returns and were doing nothing to help 401(k) participants regain some of the ground they had lost during the 2008-09 stock market decline.  Another Wall Street Journal Article in early 2011 cited an Alliance Bernstein survey of 1,000 workers which over half “mistakenly believed that using target-date funds would guarantee that their retirement income needs will be met.”

As both a financial planner working with individual investors and as an advisor to several 401(k) plan sponsors I find this survey result appalling and disturbing.  Moreover, it reinforces my concerns that 401(k) participants as well as some plan sponsors really don’t understand the pros and cons of Target Date Funds.

The fund companies offering them would be the first to tell you that there is nothing guaranteed about TDFs. There is a growing movement within the retirement plan space to add guaranteed-income products to Target Date Funds, but this won’t guarantee retirement success either.

Is a Target Date Fund the right choice for you?

The key to determining if a Target Date Fund is the right choice for your retirement savings is to understand them.  If you are considering a TDF for all or part of your 401(k) account or as an investment in general, here are two things to consider:

  • Target Date Funds from various providers with the same target date may vary widely as to their asset allocation and investment approach. There is no requirement that a TDF with a given target date have any particular allocation to equities, fixed income, etc.  The fund with the target date closest to your intended retirement might not be the best fund for your needs. As with any investment, you need to look at the fund’s investment allocation in light of your financial goals, risk tolerance, etc. You should also look at the fund as a part of your overall portfolio if you have investments outside of your retirement plan, such as IRAs, taxable accounts, a spouse’s retirement plan, and the like.
  • Many Target Date Funds are funds of the mutual fund company’s funds. This is the case for Vanguard, Fidelity, and T. Rowe Price, which collectively have about 80 percent of the TDF assets. This is not good or bad, but you should take a look at the funds that make up the TDF that you are considering. In some cases, I’ve seen fund companies use funds other than what I consider to be their top funds; perhaps they are looking to add assets to these funds.

Target Date Funds gather a huge amount of assets for the fund companies offering them, both as a component in many 401(k) plans and as a rollover vehicle when participants leave their employer.  Remember your investment choices should be all about you and what’s right for your situation.

Most of all, remember that the biggest single determinant in retirement success is the amount saved. If you start early, save as much as you can, have a financial plan in place, and make good investment choices, you will give yourself a good shot at accumulating enough to fund your retirement.  There are no guarantees of course.

Please feel free to contact me with questions about 401(k) plan and about your retirement planning needs.

Check out our Resources page for links to a variety of tools and services that might be beneficial to you.

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Vanguard Target Date Funds – A Look Under The Hood

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I’ve written several posts on Target Date Funds for this blog.  I have mixed feelings about them.  On the one hand TDFs do

Vanguard

provide investors with a professionally managed all-in-one investment solution.  Ideally you invest in the fund with a target date closest to your anticipated retirement date and the fund does the rest.  The manager typically lightens up on equities over time until the fund reaches its Glide Path into retirement, which is a point where the equity allocation levels off and you “glide” into retirement.

This is great in theory, but the reality is that across various fund families TDFs with the same target date can vary widely in their allocations and as to when the Glide Path starts.  Personally I like TDFs more for younger investors versus those who are within say 15 years or so of retirement.  Target Date Funds have become a staple in 401(k) plans due to the safe harbor given to plan sponsors who use them as the default investment choice for those plan participants who do not make an election of their own.

Fidelity, T. Rowe Price, and Vanguard control about 80% of the TDFs assets.  Let’s take a look under the hood at the Vanguard Target Retirement funds.

Vanguard offers funds with target dates beginning in 2010 and going out to 2060 in five year increments.  Additionally they offer an Income version of the fund for those already in retirement.

Low Cost and Simple

Vanguard’s approach is both simple and low cost.  The underlying funds consist mostly of Vanguard’s low cost index funds.  The overall expense ratio of the funds is a weighted rollup of the underlying funds and currently ranges from 0.17% to 0.19%.  This is far less expensive than either Fidelity or T. Rowe Price and each of the Vanguard funds ranks in the top (lowest expense) percentile of their respective peer categories.

Solid Performance

  • Each of the funds from the 2010 through the 2050 fund received a top ranking from Fi 360 a mutual fund and ETF ranking service that I utilize in their most recent rankings through the quarter ended September 30, 2012.
  • The Retirement Income fund received a score of 6 from Fi 360 meaning that it ranked in the top 6% of the 211 funds in its category based upon the 11 ranking criteria used by the service.
  • The 2055 and 2060 funds do not have enough history to receive a ranking.

Glide Path and Asset Classes

Vanguard uses 7 asset classes in its TDFs; Fidelity uses 11; T. Rowe Price uses 12.  This is not good or bad, but does reflect Vanguard’s more basic approach.

Vanguard’s Glide Path levels off at age 72; Fidelity’s at age 80; T. Rowe Price’s at age 95.  The Glide Path assumes that the investor will hold the fund until death; this may or may not be the case in reality.

Are Target Date Funds the Right Answer? 

As mentioned above, I have mixed feelings.  On the one hand TDFs are often a better solution than simply letting one’s retirement plan assets languish in a money market account.  On the other hand I am convinced that investors who are either comfortable doing their own allocation or who utilize an advisor are generally better served by tailoring an allocation from among the menu of investment choices offered in their 401(k) plan.

As far as Target Date Funds go, I generally like the Vanguard version for their basic, easy to understand approach and their low cost.

Check out Morningstar to look under the hood of Vanguard’s Target Date Funds and to compare them against other alternatives that you might be considering.  Get a  free trial for their premium services.

Please feel free to contact me with questions regarding your investments and your retirement planning issue.

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Target Date Funds – A Look under the Hood

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Asset Allocation on Wikibook

The Pension Protection Act of 2006 made Target Date Funds the default investment option of choice in many 401(k)

plans.  As of March, nearly 25% of all 401(k) participants invest solely in TDFs representing a 6 fold increase in six years according to Vanguard via research for plans they manage.  Vanguard goes on to say that 64% of new plan participants entering a plan for the first time contributed 100% to a single TDF.

When you invest in a Target Date Fund, where is your money going?  Here is a comparison of the TDF series offered by the “Big 3” Vanguard, Fidelity, and T. Rowe Price who control about 80% of the Target Date Fund assets.

Fund Basics

Fidelity

T. Rowe Price

Vanguard

Number of underlying mutual funds

23

19

5

Glide Path end age

80

95

72

Active/passive focus

Active (89%)

Active (85%)

Passive (97%)

Expense ratio-avg.

0.64%

0.70%

0.18%

Information via Lipper and Morningstar

Looking at some of the basics from the chart above:

  • All three families are funds of funds comprised exclusively of their own mutual funds.
    • Fidelity and T. Rowe Price both use a higher number of undying funds as compared to Vanguard.
    • Vanguard’s funds are lower cost due to their focus on passively managed index funds.
  • Vanguard and T. Rowe Price use the same underlying funds that are generally available to investors.  Fidelity has moved in large part to the use of their Series funds, a group of institutionally managed funds designed for use only in their Target Date Funds.
  • Glide path refers to the leveling out of the allocation to equities in the funds as shareholders move into retirement.  All three funds are “through” retirement rather than ‘to” retirement.  In the latter case the glide path would level off around age 65.
  • T. Rowe Price has among the longest glide paths of all TDF families.  As you can see above, Fidelity and Vanguard level off a bit earlier.  A point about the glide path.  The fund companies assume that you will hold the TDFs through retirement and perhaps until death.  You might or might not do this, if you don’t the glide path does not make as much difference.

A look at the asset classes used by each TDF family shows some additional differences

Asset Class Summary

Fidelity

T. Rowe Price

Vanguard

U.S. Large Cap

X

X

X

U. S. Mid Cap

X

X

X

U.S. Small Cap

X

X

X

International Equity

X

X

X

Emerging Markets Equity

X

X

X

U.S. Fixed Income

X

X

X

U.S. TIPs

X

X

X

High Yield Fixed Inc.

X

X

International Fixed Income

X

Emerging Mkts Debt

X

X

REITs

X

X

Commodities

X

X

Source:  Lipper 

As you can see from the chart above, Fidelity and T. Rowe Price have ventured into a number of non-core asset classes.  The allocations to any of these asset classes of course vary based on the allocation of the particular TDF.

Vanguard has chosen to take the approach of building their asset allocation models across the various target dates using a simpler approach with just five funds across seven asset classes.

According to Morningstar both T. Rowe Price and Vanguard are ranked “Top.”  Morningstar uses a five rank system.  Fidelity’s Freedom Funds are ranked as “Average” the middle ranking.  This is as of June 30, 2012.

Target Date Funds are a staple in 401(k) and similar retirement plans.  As mentioned above they are frequently used as the default option for participants who don’t specify an investment choice.

As far as choosing which family of TDFs to use, you generally won’t have a choice in your 401(k).  Understand, however, that TDFs can generally be used outside of retirement plans.  For example all of the “Big 3” actively court rollovers from the retirement plans they manage for participants who are leaving the plan for whatever reason.

Besides the fund of proprietary funds approach used by these three families, there are Target Date Funds out there using ETFs and other vehicles as the underlying investments.

Should you go the Target Date route?  Here are a few factors to consider:

  • Are you comfortable allocating your retirement account from among the other options available in the plan?
  • Are there advice options available to you via your retirement plan?  These might include online options; in-person individualized sessions; or managed account options.
  • Do you work with a financial advisor on your accounts outside of the plan?  If so the advisor might be in a position to provide advice on your 401(k) account.  In any event these assets should be considered by your advisor in the course of the advice they provide to you.

If you decide that the Target Date Fund route is the best route for your situation, here are a few things to consider:

  • Pick the fund that best fits your unique situation; this may or may not be the fund with the target date closest to your anticipated retirement date.
  • Target Date Funds are not a “set it and forget it” option.  There, in my opinion, is no such investing option for your 401(k) or any other account.  You need to monitor your TDF choice and understand how your money is being invested.  Fund companies can change managers, investment philosophies, etc.  You are responsible for your retirement and need to stay on top of it.
  • The use of a TDF does not guarantee retirement savings success.  The biggest determinant here is the amount saved during your working life.  Make sure that you are maximizing the amount you are able to contribute to your plan.
  • TDFs do not lower investment risk; this is a function of how the fund is allocated and the skill of the investment manager.  Just ask holders of many 2010 dated funds back in 2008.
  • You need to understand how the allocation of the TDF you choose will fit with your other investments, whether other funds in the 401(k) or your outside accounts such as IRAs and taxable brokerage accounts.

While I’m not a huge fan of Target Date Funds, they can be a sound alternative for many 401(k) investors.  Make sure you have researched this and all options available via your 401(k) plan to determine if this is truly the best option for you.  Check out morningstar.com to analyze your Target Date Fund choices and all of your 401(k) options, and to get a free trial for their premium services.

If you have a choice of Target Date Fund families remember to look “under the hood” of each because there are differences in approach, the types of underlying investments, and costs.  There are also differences in the allocation and risk of funds from difference families with the same target date.

Please feel free to contact me with any questions you may have about your 401(k) plan or with regard to your overall financial planning needs.

 

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What Does My Fidelity Freedom Fund Invest In? – An Update

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In February of 2010 I posted “What Does My Fidelity Target Date (Freedom) Fund Invest In? “ It is time to update this analysis.

Using the same methodology as the last post, I combed through each of the individual Fidelity Freedom funds and made a list of their underlying holdings. The Fi360 Toolkit which rates funds based on an 11 point criteria was used to review the underlying funds:

• Fund inception date (at least three years)

• Manager Tenure (min. 2 years)

• Minimum fund size

• 2 measures relating to fund investment style and asset composition

• Expense ratio

• 2 measurements of risk-adjusted return

• Trailing 1,3,5 year returns

Of the 23 non-money market funds used inside the Freedom Funds (all rankings as of June 30, 2011):

• One of the funds received the highest ranking of 0. This means no deficiencies, they passed all criteria.

• An additional three funds earned a score ranging from 1-25 indicating that they passed most of the criteria. This would indicate that these funds rank in the top 25% of all funds in their peer group with enough data to be ranked.

• Three funds had scores ranging from 26-50 indicating that they did not pass in a couple of areas but overall rank in the top half of their respective peer groups based upon the ranking criteria.

• Three of the funds had a ranking in the 51-74 range indicating that they were deficient in several of the criteria and overall place in the lower half of their peers with enough history to be ranked.

• One fund had a score in the bottom quartile of the ranking meaning that it was deficient in most areas and ranked in the bottom 25% of its peers. A ranking in this range indicates that strong consideration should be given to replacing such a fund.

• Twelve of the funds did not have enough history to be ranked. These funds are all Fidelity Series funds. This appears to be a new group of funds that Fidelity has designed for use in their Freedom Funds. These may ultimately prove to be good funds over time, but as an advisor I am generally loath to invest client money in new, untested funds unless there is a compelling reason to do so. In looking at the returns posted by these unranked funds, the results are middling at best.

• Noticeably absent from the underlying funds within the Freedom Funds are any of Fidelity’s low cost core index funds covering areas such as the S&P; 500; total domestic stock market; international equities; or their total bond market index fund. These are by and large solid, low cost holdings. Also absent are several top Fidelity funds such as Contra, Low-Priced Stock, and others.

Reviewing the overall performance of the 12 Freedom Funds compared to their peers in the Fi360 rankings:

• One fund received 0 the highest score available

• Three of the funds received scores ranging from 1-25 placing them in the top quartile of their peer group.

• The rest of the eight funds earned a score in the 26-50 range, placing them in the second quartile of their peer group of funds.

Note these ranking are in line with Morningstar’s evaluation of the Freedom funds as of June 30 in which they ranked this group of funds as Average. Morningstar ranks 20 Target Date families each quarter.

Target Date Funds are typically funds of funds that are managed towards the target retirement date in the fund’s name. Fidelity, for example has target date funds with dates that range from those currently retired out to the year 2050. Target Date Funds are a staple of 401(k) and other defined benefit retirement plans.

All too often a retirement plan sponsors will default to the suite of Target Date Funds offered by the platform used by the plan provider. In fact, plan sponsors need to perform the same level of due diligence on the Target Funds they offer in the plan as with any other investment choice included in the investment menu.
Target Date Funds have been marketed as a one-decision set it and forget it investment option. In my opinion, there is no such investment option.

Investors considering a Target Date Fund need to do their analysis of the fund(s) they are considering to determine if this is an appropriate investment for them. Further investors should not feel compelled to invest in the fund with the target date closest to their projected retirement date, but rather should pick the fund that best matches their investment objectives.

Please feel free to contact me with questions about Target Date Funds or to address your investment and financial planning advice needs. 

Do-it-yourselfers check out morningstar.com to analyze your investments and to get a free trial for their premium services. Check out our Resources page for links to a variety of tools and services that might be beneficial to you.

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Are Target Date Funds On Target for You?

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Target Date Funds are a fixture in many 401(k) plans.  They are a good idea in concept, the execution has not always been terrific.

I recently wrote 5 Considerations for Investing in Target-Date Funds for the US News Smarter Investor Blog:

Target-date funds are a staple of many 401(k) plans. Most target-date funds are funds of mutual funds. The three largest firms in the target-date space are Fidelity, T. Rowe Price, and Vanguard with a combined market share of about 80 percent. All three firms use only their own funds as the underlying investments in their target-date fund offerings. Some other firms offer other formats, such as funds of exchange-traded funds, but the fund of mutual funds is still the most common structure.  

Here are a few considerations to think about when deciding whether to use a target-date fund option in your company’s retirement savings plan:  Click here to read the rest of the article.

Target date funds, like any investment, require thorough analysis to determine if they are the right choice for your personal situation.

Retirement plan sponsors also need to perform their due diligence on Target Date Funds before offering them as an option in their company’s plan.  All TDFs are not created equal.  There are wide variations in the equity percentages at the various target dates and in the various glide path philosophies.  This is not to say that any particular approach is right or wrong, but rather plan sponsors need to look at all aspects of a particular family of Target Date Funds to determine if they are the right choice for their plan, given the demographics of their participants.  In short, plan sponsors need to analyze their choice of Target Date Funds as diligently as they would any other investment option offered by the plan.

One size does not fit all here no matter what the fund companies or the plan providers might want you to believe.

 

 

 

 

Target Date Funds-A No Brainer?

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When they were introduced, Target Date Funds (TDFs) were touted as a no brainer investment. Much of the education presented by fund companies to 401(k) participants portrayed these funds as a place where participants can “set it and forget it.”

In my opinion, no such investment exists. I’m not knocking TDFs. Rather 401(k) participants need to understand what they are investing in and whether or not these TDFs are right for their unique situation. Is the fund nearest their probable retirement date too heavy or too light on equities for their goals and risk tolerance? 

Further, 401(k) plan sponsors also need to perform their due diligence. Just because their plan is with the likes of Fidelity, Principal, or the American Funds doesn’t mean that any of these provider’s TDFs are right for their participants. It is incumbent upon plan sponsors to “look under the hood” of these funds. What are the fund’s underlying investments? Are they too heavy or too light in equities in the various target years? What does each group’s glide path into retirement look like? Do their participants tend to leave their money in the plan at retirement or do they tend to roll their money out of the plan? Plan sponsors need to perform the same level of due diligence with the selection of TDFs as they would with any other investment choice. 

JP Morgan has a tool called Compass that compares the makeup of various near-dated TDFs (currently the 2010 funds). The range in equities among the 40 funds shown in the JP Morgan analysis was from about 20% to almost 75%. The recent Congressional hearings on TDFs illustrated that two funds with the same target date might have radically different investment allocations and levels of risk.

My bias would be for plan sponsors to offer their participants access to qualified unconflicted advisors. These advisors are able to offer each participant specific advice as to how to allocate their accounts from among the investment options offered by the plan. Perhaps the recently passed Financial Reform Bill and the pending Advice Provisions of the Pension Protection Act (PPA) will help plans to move in this direction. Participant education is fine, but plan participants are better served by direct, live investment and retirement planning advice.

Need help allocating your 401(k) account?  Plan sponsors do you want an objective look at your company’s plan?  Please feel free to contact me.

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What Does My Fidelity Target Date (Freedom) Fund Invest In?

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Fidelity is one of the largest providers of 401(k) plans and like many fund company platforms it is common for their plan sponsor clients to offer several or all of Fidelity’s Target Date funds known as the Fidelity Freedom funds. These funds have target dates from 2005 every five years out to 2050 with an even shorter-term Retirement Income fund. The premise behind these and other Target Date funds is that a plan participant will choose a fund with a date close to when he or she might retire, invest their contributions and let the fund manager do the rest. The funds typically lighten up on equity investments as the target date draws nearer, at some point they go to a “glide path” into retirement typically at the target year. This means the fund at that point is geared to the typical life expectancy of someone retiring in that year, the allocation allows the fund shareholder to “glide” into retirement.

There has been much controversy as to whether Target Date funds work as advertised. My purpose in writing this post is not to comment on these issues one way or the other. Rather I want to take a look at how the Fidelity Freedom Funds actually invest shareholder’s money.

The Freedom Funds like many Target Date funds are funds of funds. Each Freedom Fund has its own mutual fund ticker symbol. Unlike many mutual funds which make direct investments into individual stocks or bonds, the Freedom Funds invest in a variety of Fidelity mutual funds. Which funds and the percentage held of each fund will vary by Freedom Fund. I made a list of their underlying holdings using Morningstar’s Advisor Workstation. I then used the Fi360 Toolkit to rate these funds based on their 11 point criteria:

• Fund inception date (at least three years)
• Manager Tenure (min. 2 years)
• Minimum fund size
• 2 measures relating to fund investment style and asset composition
• Expense ratio
• 2 measurements of risk-adjusted return
• Trailing 1,3,5 year returns

All funds are rated relative to other funds in their peer group.

In looking at the 26 Fidelity mutual funds that I found as holdings of the various Freedom Funds I found the following for the ranking period ending 12/31/09:

• Three of the funds received the highest ranking of 0. This means no deficiencies, they passed all criteria.
• An additional four funds earned a score ranging from 1-25 indicating that they passed most of the criteria. This would indicate that these funds rank in the top 25% of all funds in their peer group with enough data to be ranked.
• Four funds had scores ranging from 26-50 indicating that they did not pass in a couple of areas but these funds overall rank in the top half of their respective peer groups based upon the ranking criteria.
• Five of the funds had a ranking in the 51-74 range indicating that they were deficient in several of the criteria and overall place in the lower half of their peers with enough history to be ranked.
• One fund had a score of 87 meaning that it was deficient in most areas and ranked in the bottom 13% of its peers. A ranking in this range indicates that strong consideration should be given to replacing such a fund.
• Nine of the funds did not have enough history to be ranked. These funds are all Fidelity Series funds. This appears to be a new group of funds that Fidelity has designed for use in their Freedom Funds. The funds all have anywhere from a month’s worth of history out to about a year. They would flunk the inception date test for the amount of time the fund has been around. These may ultimately prove to be good funds over time, but as an advisor I am generally loath to invest client money in new, untested funds unless there is a compelling reason to do so.
• Noticeably absent from the underlying funds within the Freedom Funds are any of Fidelity’s low cost core index funds covering areas such as the S&P; 500; total domestic stock market; international equities; or their total bond market index fund. These are by and large solid, low cost holdings. Also absent are several top Fidelity funds such as Contra, Low-Priced Stock, and others.

In their defense of the 11 numbered Freedom Funds, 10 earned a score of 0 for the most recent ranking period and the other one earned a top quartile score of 20. Keep in mind; however, these rankings are within the target date peer groups via Morningstar. All of these groupings have a small number of funds and there is not a lot of history in some cases. A really good or really bad quarter or two can skew a target fund’s relative ranking. Additionally the peer groupings have changed and been revamped at least twice in the past several years.

Should you invest in these funds? As a plan participant you need to understand the fund’s investment philosophy, the glide path concept, and the fund’s underlying investments. Remember just because a particular fund has a target date closest to when you might retire, you can go with a closer date fund if you want to be a little less aggressive or a longer-dated fund if you want to be a bit more aggressive.

Plan sponsors it is incumbent upon you to monitor the Target Date funds in your plan as closely as you would review any plan investment choice. In the case of a Fidelity plan you may or may not be limited to the Freedom Funds.

Again I am not saying the Freedom funds are good or bad. Clearly they did well relative to their peers in 2009. Participants and Sponsors need to understand these funds and what they can and cannot offer.

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