What is a Target Date Fund & should you consider it for retirement?

Retirement planning is one of the key aspects of the Personal financial management which a lot of us conveniently procrastinate about & forget to realize its importance until it is too late. The statistics are pretty scary as well – one in three Americans have nothing saved for retirement and the proportion is even higher among Millennials where more than 40% haven’t even begun saving for retirement. As we continue to live longer, the importance of a stable source of income during retirement years has become even more important. And for that, we need to choose a savings plan which matches our risk profile, retirement objectives & income expectations.

Some baseline factors that almost everyone needs to consider while devising a retirement plan are:

The Portfolio should be broadly diversified
Cost of Plan management should be minimized
Forced saving habits should be reinforced
Resist distractions & the urge to change the objectives due to short-term factors
Choosing a Financial Planner who has a good track record & whom you can trust

A lot of employers in North America have Defined Contribution Pension Plans in which you contribute a fixed amount from every pay cheque & in some cases your employer matches the contribution as well. If this is the case target date fund may be the ideal solution. This saving instrument was introduced in the early 90s in the U.S by Donald Luskin and Larry Tint (Wells Fargo Investment Advisers at the time). They are now pretty widespread across America & Canada. These target funds can be added to both your 401(K) plan in the U.S & group RRSP in Canada.

The mechanism behind these date funds is pretty simple – it is a balanced portfolio of domestic & global equities, bonds, T-bills etc. with a calendar year defined in the name of the fund like “target date fund 2060”. The investments in this assigned portfolio are professionally managed for a person who is planning to retire closer to the date mentioned in the target fund. The investment mix is continually monitored & changed as the plan holder gets closer to the retirement. This is a called a “glide path” where younger people have more time to ride out the fluctuations in the portfolio mix & can thus take a larger risk, however people closer to their retirement, who are looking towards a stable income stream (risk averse) will have more bonds & fixed income-producing assets in their plan.

These are the Top 5 Target Retirement Funds out there:

Vanguard Funds – This is the giant among this group of retirement funds with $381 billion in assets and an expense ratio of only 0.16%. Vanguard funds are the most globally diverse with a mix of 40% of foreign stocks & 30% of foreign bonds. The underlying funds all contain index funds which is the main reason of its popularity.
Fidelity Freedom funds – Fidelity manages $228 billion in assets & charges 0.61% on an asset-weighted basis. Although pretty competitive to Vanguard in size & performance, Fidelity 2030 fund is about 10% more volatile than the Vanguard 2030 fund.
T. Rowe Price Retirement funds – manages assets worth $106 billion with the highest investment in stocks among the top funds. Its 2020 fund has almost 55% invested in stocks as compared the industry standard of 43%. The fee is higher than Fidelity & Vanguard at 0.69% but the funds have been outperforming with a bullish stock market. The funds obviously lagged behind in the bear market of 2007-09 with this mix.
American Funds Target-Date Retirement funds – is well-known for its offering of large-cap stock options in its funds which have been performing really well in recent years. American funds has assets of $88 billion with a fee of 0.66% but with very little to offer in small-cap options, it is perhaps not as competitive as its contemporaries.
JPMorgan SmartRetirement funds – has the most conservative investment in stocks of 38% among the industry average of 43% in its 2020 fund based on its research that investors nearing retirement are uncomfortable with such a hefty allocation in stocks. The funds have nevertheless done well with a good team managing the fund. The fee is also a competitive 0.67% annually.

To end it all here is a useful infographic detailing the investing strategies at different stages of like with some useful visuals on target date funds.