Two target-date funds with the
same retirement year won’t necessarily achieve the same performance. In fact,
the difference in results may be quite significant.
Target-date funds typically comprise
cash, stocks and bonds in a portfolio that becomes more conservative as the
retirement date chosen by the investor nears. Such funds became popular when
the Pension Protection Act of 2006 allowed them to be offered as the default
investment option in various retirement plans, including 401(k)s.
Target-date-fund providers say
investors can easily put together a suitable portfolio simply by choosing a
fund that corresponds to their expected retirement year; then, after they
select a fund, they can just let it ride while the fund managers adjust the
asset allocation to become more conservative as the years go by.
But firms can use very different formulas
within this broad framework, which means investors need to take a closer look.
"What they own or don't own, and how much of it they own, dictates
performance," says Phil Chiricotti, president of the Center for Due
Diligence, a firm that serves the retirement-plan industry. In 2013, when the
S&P 500 soared more than 30%, it's no surprise that target-date funds with
a heavier U.S.-equity allocation did particularly well.
Those big 2013 gains also largely explain
how funds stack up for the 12 months through April. For example, American Funds 2025 Target
Date Retirement rose 14.9% in the 12 months through April, making it the
best performer among its peers, according to Thomson
Reuters Corp.'s Lipper unit. At the bottom of the
RealRetirement 2025 rose 1.4%. The two funds recently had 81% and 12%,
respectively, allocated to equities, according to Lipper.
Indeed, over the past five years, the range
of returns among funds with the same target year has increased, in part because
more funds have come into the market.
Some are using different
investment strategies to stand out in an increasingly crowded market, and differences
in the performance of equity and fixed-income markets have played a big part as
Three,” and Others
The target-date-fund space is dominated by three big players: T. Rowe Price Group, Fidelity
Investments and Vanguard Group. Their funds' performance has been similar so
far this year, though T. Rowe Price has been slightly heavier in equities. Overall,
assets in target-date funds climbed to $644 billion as of March 31, from $248
billion in 2009, and the big three players account for about 73% of those
assets, according to Lipper.
As other providers try to gain market share, some target-date
funds are trying to stand out from the pack by using unusual investment
approaches. But diversifying beyond ‘plain-vanilla’ stocks and bonds last year,
into areas like emerging markets, real estate, Treasury inflation-protected
securities, natural resources and commodities, generally reduced performance,
says Mr. Chiricotti. Many bond investments lost money as some interest rates
rose, depressing prices. That in turn hurt funds aiming to be more conservative,
who tended to hold more dollars in bonds.
At the same time, some fund
managers emphasized the view that minimizing losses matters more than gains
when trying to accumulate capital or derive an income from a portfolio, and
that a stock-heavy allocation will provide not only higher gains in some years,
but larger losses in others, potentially throwing a target-date fund off track.
Retirement savers should not
forget that an asset class that is a drag in one year could fuel a fund's
performance in the next. Moreover, investors should not count on stocks
performing as well this year as they did in 2013, and so they may want to scale
back expectations for equity-heavy target-date funds. So far this year though,
there haven't been large variations between the best and worst-performing target
More generally, in selecting a
target-date fund, investors should above all pick one that suits their risk
tolerance and fits with their overall portfolio. They should be comfortable
with the fund's "glide path," or how the fund resets its asset mix to
become more conservative as the investor nears retirement.
There is no one formula that is
universally ideal, as people have different goals and needs. But familiarity
and comfortability with the fund’s broader strategy will help investors stick
with it for the long term, which is important since bailing out in a down year
is usually counterproductive.
And, of course, never forget
that fees eat into returns regardless of what's happening in the market.
Don't chase performance, and
always look for low fees.
This article includes information drawn from
research in the Wall Street Journal.