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.
I typically try and stay away from target date funds as everyone’s situation and risk tolerance is different. Good to hear Morningstar changed up their ranking system.
Thanks for your comment. TDFs are a great idea which is not always executed as well as we might like. I generally like TDFs for younger investors (as you know TDFs are a staple in 401(k) and similar retirement plans). For folks say within 15 years of retirement I generally would encourage they have a more tailored allocation ideally tied into their financial plan.
Roger:
Great article. I love the detail and rigor.
What do you think about a fund rating system that focuses on analyzing the quality of holdings?
A lot of ETFs have similar names and it can be hard to distinguish one from another without looking at holdings.
Thank you,
David
Thanks for the comment and the compliment David. I’d be surprised if somebody somewhere wasn’t doing that already. I have mixed feelings. When you hire an active manager you are hiring them for their skill and it makes sense to judge them against a benchmark. Presumably they are picking good stocks and if they aren’t their performance would lag. When it comes to an index product you are buying that index and the quality of the holdings are what they are good or bad.