Whether you’re hoping to retire in the next three years or 33 years, it’s never too late to evaluate your wealth-accumulation strategies.
But deciding how to build that comfortable nest-egg can be intimidating. There are plenty of ways to get started, and target-date funds are one of the best.
Target-date funds, also known as life-cycle or age-based funds, are mutual funds matched to a specific retirement time-frame.
As we explained in our article, 'Are Target-Date Funds Right for You?', there are several benefits to target-date funds. First, they rebalance their asset allocation of stocks, treasury and corporate bonds as they mature and as you age. That way you are invested in an age-appropriate portfolio which is professionally managed. Target-date funds cater to those wanting to 'invest and forget.'
But, not all target-date funds are created equal. Some can help you realize your retirement goals more effectively than others.
To help you evaluate the best target-date funds, here are three key points to consider:
Like it or not, you pay for the convenience of investing in a target-date fund. With each position in a target-date fund, you are charged a percentage-based fee. Fees vary widely, so do your research. The less you pay in fees, the more money you’ll end up with in the long run. And don’t be fooled -- what appears to be a small percentage difference can add up to big money in the end.
Typically, fees increase the further away you are from your retirement horizon. If you’re looking at a target-date fund that matures in 33 years, you’ll pay much more than for a fund maturing in three years.
We did some digging and found that funds with a target date of 2026 to 2030 currently have expense ratios ranging from about 0.18% to 1.9% of the fund's average annual net asset value; the average is about 0.62%. That's a huge variation and one that can greatly affect the total returns you receive.
Generally speaking, Vanguard funds offer the lowest expense ratio, hovering around 0.18%. T. Rowe Price funds are about in line with the industry average; expenses range from 0.56% to 0.76%, depending on your retirement horizon. At 1.9%, Manning & Napier Target 2030 Series Fund (MTPCX) appears to be the most expensive fee out there.
Always remember the adage “buyer beware.” On top of the advertised fee, some funds also charge additional fees to pay the brokers who sell the fund, which can again reduce your returns. So from this standpoint, Vanguard funds offer an attractive starting point.
For a more complete look at target-date fund fees, you can check out this Average Expense Ratio table posted in the Wall Street Journal. U.S. News’ Best Mutual Funds Rating article is also a good resource.
While it’s important to know how much it will cost you to invest in a target-date fund, it's even more crucial to determine the total returns you'll receive. This factor is largely determined by the fund’s market performance.
Unfortunately, fund managers don’t come armed with crystal balls; future performance can only be estimated. It’s based on past history and then projecting that trend into the future.
Looking again at funds with a target date of 2026 to 2030, here are some of the top-performing funds. The T. Rowe Price Retirement 2030 Fund (TRRCX) at present has an annualized average 3-year return of 22.3%. That's versus the Morningstar Moderate Target Risk category return of 16%.
Following closely behind is the Invesco Balanced-Risk Retirement 2030 Fund (TNAAX), with a 21.9% 3-year annual gain. The John Hancock II Lifecycle 2030 Fund (JLFAX) follows suit, with a 3-year annualized return of 21.0%.
However, over the past year, the TNAAX fund takes the cake, giving a total return of 15.5%. The American Century Asset Allocation Portfolios LIVESTRONG 2030 Portfolio (ARCMX) trails a distant second with 6% return over the year. So, study the fund's past performance and pick it carefully depending on your selected timeframe.
A key investing principle is to reduce risk exposure as you age. The closer you are to retirement, the more secure you want your assets to be. The beauty of target-date funds is that asset allocation automatically adjusts to reduce risk exposure as your investment draws to maturity.
However, not all target-date funds are allocated equally. Each has its own balance of domestic and overseas stocks and bonds, as well as other assets, like cash. The diversification and allocation of these assets will widely influence your fund’s performance.
Looking at two of the funds outlined above, (TRRCX, TNAAX), we can see just how widely asset allocation varies.
TRRCX is primarily allocated in domestic stocks (57.5%), foreign stocks (25.3%), domestic bonds (8.5%) and foreign bonds (3.8%). Its exposure to stocks leaves it vulnerable to the vagaries of bull and bear markets and the cycles of volatility that accompany equity exposure.
TNAAX, on the other hand, is a less risky investment. The fund is heavily invested in domestic bonds (48.6%), followed by cash (33.2%), other (9%) and foreign stocks (9%).
Before investing in any target-date fund, carefully investigate the portfolio of the target fund you are considering and assess its weighting toward riskier stocks or bonds; if they are of investment quality, the securities tend to be much safer, even though they may provide less robust returns.
The Investing Answer: There’s no perfect target-date fund. Some offer lower expense fees but do not provide strong historical performance. Others have performed well, but carry greater risk. While we are not recommending or endorsing any specific target-date funds, the best investments are ones that offer a balance of expense to performance to risk. Keeping these tips in mind will help you find the target-date funds that are right for you in your specific retirement time frame.
Be sure to try InvestingAnswers' free savings calculators to help you determine how much you need to save to reach your financial goals.