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Target Date Funds: Does the Glide Path Matter?

February 6, 2014 by 4 Comments
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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.

Approaching retirement and want another opinion on where you stand? Not sure if your investments are right for your situation? Need help getting on track? Check out my Financial Review/Second Opinion for Individuals service for detailed guidance and advice about your situation.

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Target Date Funds – A Look under the Hood

August 6, 2012 by 11 Comments
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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.

Please check out our Resources page for tools and services that you might find useful. 

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Lousy 401(k)? – Maybe it’s You Not Them

July 30, 2012 by 8 Comments
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President George W. Bush signs into law H.R. 4...

Ever since the stock market tanked in 2008-09 there have been innumerable news stories and blog posts about how the 401(k) has failed investors.  The term “201(k)” was coined to describe the losses suffered by many investors.

It is true that there are a lot of sub-par 401(k) plans out there in the marketplace.

On the other hand, I have many clients who have or are the process of amassing significant retirement nest eggs via their 401(k) plans.

Maybe it’s not fair, but the responsibility for saving for our retirement has been placed upon us by a system that has made offering a traditional defined benefit pension plan prohibitively expensive for many employers.  For better or worse the 401(k) is the main retirement savings vehicle for many of us.  Unfortunately, in many cases 401(k) participants are their own worst enemy.  Here are some common 401(k) mistakes to avoid on the path to saving for your retirement:

Ignoring it.  How many stories have we seen over the past few years about plan participants who were afraid to open their statements?  The better solution is to be proactive:  figure out an investment strategy for your retirement savings, implement that strategy, monitor your allocation, and adjust when appropriate.

Assuming that the auto enrollment percentage contribution is sufficient to meet your retirement goals.    Trust me, it isn’t.  Many plans auto enroll all new employees unless they opt out.  Generally the deferral percentage is low, 1% or 2% of compensation is common.  This might be a good start, but if you don’t increase your contributions you can likely count on a pretty dismal retirement lifestyle.

Not taking advantage of professional help.  Many people are uncomfortable making investment decisions for any number of reasons.  If you work with a financial advisor already make sure that they are providing advice on this account as well.  Many plans offer advice services that range from online to one-on-one consultations.  Some of this help is free, some carries a cost, if you are uncomfortable managing your 401(k) yourself go get the help you need.  It’s never too early to get serious about your retirement and make sure that you are on the right path.

Assuming that that a Target Date Fund is the right solution.  On the surface the Target Date Funds offered by your plan looks like the ideal solution, especially if you are uncomfortable allocating your account from among the other investment choices offered by the plan.  This has been reinforced by the use of Target Date Funds as the default option by many plans under the safe harbor provisions of the Pension Protection Act of 2006.  What could be easier?  You pick the target date closest to when you are likely to retire, you make your contributions, and you basically set it and forget it.

Unfortunately it’s not that easy.  Target Date Funds with identical target dates can often look quite different.  Different Target Date Fund providers may offer funds that are geared “to” retirement while others are geared to go “through” retirement.  I strongly suggest that no 401(k) participant take anything on faith here.  All one needs to do is to look back on the recent performance of shorter dated funds during severe drops in the markets.  Witness the losses suffered by many Target 2010 funds during 2008.  Look closely at the Target Date Funds offered to you.  Understand how they will invest your money and what retirement Glide Path they take.  Decide if this is the right approach for your situation.  Remember, you don’t have to investment in the fund with the target date closest to your expected retirement date, go can go with any of the funds that best fits your needs.

Investing your 401(k) account in a vacuum.  I see far too many plan participants who fail to take a total portfolio view of their 401(k) account.  By this I mean including the 401(k) along with their spouse’s retirement account, IRAs, old retirement accounts still at former employers, brokerage and mutual fund accounts, individual stocks, and other holdings as a total investment portfolio.  Not doing this can cause you to take too much or too little investment risk in your 401(k).  Beyond the 401(k) having all of these accounts not being managed in harmony is just a waste of these investment dollars.  You worked hard to accumulate these assets, make them work just as hard for you.  In short develop an investment strategy that takes all of your investment assets into account, ideally one that is based on a financial plan.

It’s easy to blame the system or other factors if you are unhappy with the performance of your 401(k).  Rather than blame anyone, there is no better time to take charge of your retirement than today.

Please feel free to contact me with your financial planning questions.  Check out our Financial Planning and Investment Advice for Individuals page for more information about our services.   

 

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Target Date Funds-A No Brainer?

August 10, 2010 by 2 Comments
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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.

Please contact me with any thoughts or suggestions about anything you’ve read here at The Chicago Financial Planner.

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