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All Contents © 2019The Kiplinger Washington Editors
By Steven Goldberg, Contributing Columnist
| May 21, 2018
Investors are flocking to target-date retirement funds. These funds, which often are the default option in workplace 401(k) plans, received $70 billion in net inflows last year, bringing their total assets to over $1 trillion, according to a new report from Morningstar.
Most investors don’t have much expertise in building a portfolio of mutual funds. But target-date funds – which invest across several asset types, in different allocations, as you age – do it all for you. All you have to know is what year you plan to retire. If you plan to retire in 22 years, you’d pick the Vanguard Target Retirement 2040 Fund (VFORX), for example. The fund will become more conservative as you get closer to taking your money out in retirement.
Expenses on these funds are falling. The annual asset-weighted expense ratio of target funds dropped from 0.91% five years ago to 0.66% at the end of last year, according to Morningstar, which supplied the data for this article. (Asset-weighted expense ratio tells you the expense ratio of the average dollar invested in the funds.)
All five of the target-date fund families offerings reviewed here include quality products – good enough, indeed, for any investor who wants a one-decision investment plan.
My advice no matter which fund you employ: These funds are designed for everyone. Consequently, even the best of them tend to lean a bit too conservatively for some tastes. You may want to buy as if you were five years younger, which will get you a slightly more aggressive mix.
Data is as of May 16, 2018.
With $381 billion in assets, Vanguard funds are the 800-pound gorilla among target retirement funds. No surprise here: Investors associate Vanguard with low-cost indexing, and that has been the “in” flavor for years now among mutual funds. The asset-weighted expense ratio is a mere 0.13% annually, and the underlying funds are all index funds.
The most surprising feature of Vanguard’s target funds is their emphasis on foreign stocks and bonds. About 40% of stocks are foreign and about 30% of bonds are foreign. That makes the Vanguard funds the most globally diverse of target funds. Vanguard may be overdoing foreign – 30% or 35% foreign stocks may be better – but other than that, there are no obvious flaws in the Vanguard entry.
For young investors, Vanguard invests 90% in stocks until 25 years before retirement, when the stock percentage begins a gradual descent. Seven years after retirement, the fund hits its low of 30% stocks.
If Vanguard is plain vanilla, Fidelity, with assets of $228 billion, is dark chocolate with whipped cream and a cherry on top.
For younger investors, 20% of fund assets are managed by Fidelity’s marquee stars: Will Danoff of Contrafund (FCNTX), Joel Tillinghast of Low-Priced Stock (FLPSX) and Steve Wymer of Growth Company (FDGRX). The Fidelity retirement funds charge 0.61% on an asset-weighted basis.
Consider Vanguard’s 2030 fund versus Fidelity’s. During the past five years, the Fidelity fund has beaten the Vanguard offering by an average of four-tenths of a percentage point per year. Over the past 10 years, Vanguard is the winner by an average of six-tenths of a percentage point per year. Fidelity bumped up its allocation to stocks by roughly 10 percentage points in 2013, and that has been a plus. But the Fidelity 2030 fund is about 10% more volatile than the Vanguard 2030 fund.
In my view, Vanguard and Fidelity both offer superb retirement funds. They’re just very different from each other. Only time will tell which will do better.
T. Rowe Price (TROW) has some of the best target retirement funds on the market. Its funds, with assets of $106 billion, are among the most stock-heavy target funds. For instance, its 2020 fund has 55% in stocks compared with an industry average of 43%, Morningstar reports. I think 55% is a more sensible allocation for someone 1 ½ years from retirement.
Bigger-than-ordinary allocations to stocks have helped the T. Rowe funds outperform most competitors in recent years. But, of course, the market has been going up in recent years. Not surprisingly, the T. Rowe funds lagged during the 2007-09 bear market. I think the higher risks of the T. Rowe funds are well worth the higher rewards. Over the past 10 years, the T. Rowe 2030 fund has returned an annualized 6.9%, putting it in the top two percentile among its peers.
Fees are higher than Vanguard or Fidelity but still reasonable. Only a small percentage of the funds are in index funds. The asset-weighted expense ratio is 0.69%.
What really distinguishes these funds is the quality of the managers T. Rowe uses for the underlying funds. Four of the five small- and mid-cap funds are closed to new investors. This tells me T. Rowe is looking out for its target-fund investors. T. Rowe has also recently added more bond funds to its mix, bringing the total to 21 bond funds. That’s a welcome contrast to some competitors that only give investors one bond or two bond funds in their target-date funds.
American Funds offers some of the best, if not the best, large-cap stock options. For decades the funds were marketed only to investment advisors like myself, but now you can buy many of the funds' no-load F1 shares through online brokerages such as Fidelity and Schwab.
Not surprisingly, their retirement funds, with assets of $88 billion, are good, too. Not as good, perhaps, as T. Rowe Price, Vanguard and Fidelity, though, because American’s mammoth asset base and relatively small number of funds means the firm offers little in the way of small-cap options. What’s more, some of its bond funds have disappointed – a shortcoming the firm has addressed.
Nevertheless, large-cap stocks have been on a roll the past several years, which has helped returns. The funds’ returns have consistently been in the top decile among its competitors. Asset-weighted expenses are 0.66% annually.
JPMorgan’s research into investor behavior has concluded that most investors nearing retirement are uncomfortable with hefty weightings in stocks. Consequently, the JPMorgan 2020 fund, for instance, allocates just 38% to stocks, compared to 43% for the industry average, according to Morningstar.
Obviously, if investors are going to bail out of a target retirement fund because of a heavier allocation to stocks, the investors lose. Still, 38% in stocks strikes me as much too conservative.
Nevertheless, the funds have done well. Returns have been in the top decile among competitors. The chief reasons: The firm has picked good managers for the underlying funds, and the funds’ supervisors have made some short-term moves that have paid off. Asset-weighted expenses are reasonable at 0.67% annually.
Steve Goldberg is an investment adviser in the Washington, D.C., area.