Target-Date Funds: 3 Risks That You're Probably Forgetting
Steve Jobs once famously commented that simplicity is genius.
That attitude helped Apple Inc. (Nasdaq: AAPL) redefine the personal electronics space and create an entire new ecosystem surrounding its products and services.
But now, a few years after Jobs passing, it looks like the financial services industry is taking a few pointers from the late and great founder of Apple.
The growing trend has been fueled by the Pension Protection Act of 2006, which approved their use as a default option for 401(k) plan sponsors, who are allowed to automatically select them for participants who have not selected on their own.
I'm talking about target-date.
A target-date diversification with a mix of different assets. But unlike a mutual , the target-date continues to rebalance and reallocate its mix as the investor moves closer to retirement.is much like a mutual in that it provides
These target date-have become popular with investors for one very good reason: They are simple.
For most rebalancing on a yearly .investors, it's just easier to identify with a target retirement date than it is to sift through rows of small-cap mutual offerings and then think about
A target-date one-stop shop and set up a dynamic plan that evolve in the long run. With target-date automatically adjusting asset allocation as the investor moves closer to retirement, investors no longer have to worry about rebalancing their portfolios.also enables the 401(k) investor to
As you can see, target-dateare easy to understand and provide a number of benefits that regular mutual don't. That's why 25% of 401(k) assets were being held in target-date at the end of 2012.
But as with any, investors need to understand how to evaluate a target date-fund and be aware of potential risks.
Risk No. 1: Excessive Fees
If you take a look at any group of mutual funds, you are likely to see a wide range in fees and expenses. Some mutual funds carry expense ratios above 2%, while others in value territory fall safely below 1%.
Target-date expense ratio of .18%. T. Rowe are more expensive, carrying an average expense ratio of .70% with Fidelity clocking in at .60%.are exactly the same, carrying different expense ratios. In fact, the difference can be significant. In value territory, there is Vanguard, with an average
That means the basis points annually, with no risk and then reinvesting that over 30 years can have a big impact on your portfolio.from T. Rowe Price is 250% more expensive than Vanguard. Picking up an extra 50
For a $100,000 portfolio, that is $500 annual savings in expenses. Taking that $500 and contributing it back into your portfolio would grow to $28,118 after 30 years, carrying a modest 3.5% return compounded annually.
Risk No. 2: Overly Aggressive Asset Allocation
The defining characteristic of a target-date fund is its classification of investors by age. By rebalancing asset allocation (its mix of stocks and bonds) according to age, the target-date fund reduces portfolio risk as investors get closer to retirement. This is called glide path.
But there is a big difference between target-datehere as well. Some target-date are more aggressive than others, carrying different mixes of stocks at bonds at various stages of the cycle.
For example, the Fidelity ClearPath 2045 and Vanguard Target Retirement 2045, two target-date asset mixes. The Fidelity ClearPath 2045 carries an 84% allocation to for 2013, while the Vanguard Target Retirement 2045 carries 90% exposure to equity. This is an important detail that distinguishes one target-date fund from another.with the same target date, have different
Risk No. 3: Too Much Focus On Either International Or Domestic Stocks
But it's not just asset allocation that can differ from one target-date fund to another. Target-dateare also unique in how they choose to invest. Some are focused on domestic stocks, while others are more international. And that can have a big effect on the performance of a fund.
For example, Vanguard Target Retirement 2045's largest allocation is 63% for 2013 in Total. The Fidelity ClearPath 2045's largest allocation is 53% to Canadian Equity. Those are two very different core-equity strategies that target-date investors should be aware of.
TheAnswer: Target-date continue to popularity with investors. Not only are they easy to pick based on a target retirement date, they also eliminate the need for investors to rebalance annually with an evolving mix of . But even though these relatively new instruments are gaining popularity, there is still risk involved when choosing between two different . Be aware of those differences and you'll get the target-date fund that fits best.