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Investment over time

Target-Date Funds

Know the Composition of Your Target-Date Fund Over Time

Brian Mathews Dec 27, 2016




Finding the Right Asset Allocation Among Similar Target-Date Funds


To compare the differences in asset allocation and glide paths between funds, the following three 2055 target-date funds are being compared.


Fund Expenses and Asset Management Strategy Is Key

In the example above, the three 2055 target-date funds have the same objective, yet they can produce very different returns. This warrants an analysis of the funds’ compositions and glide paths.

Consider this. The Vanguard fund adjusts its asset allocation between only four index funds, making this passive strategy a cost-effective one with a mere 0.16% expense ratio. On the other hand, Fidelity and Schwab funds use an active managed approach with a mix of both index funds and actively managed mutual funds in other asset classes.

One disadvantage of such a hybrid strategy can be higher expenses. For instance, the Fidelity fund allocates assets to a broad variety of asset classes (i.e. mid cap, small cap, real estate, emerging markets and floating rate instruments), bringing its expense ratio to 0.77%. Given this, you might want to know what asset allocation really means for mutual funds.

So if you like taking risk and have enough confidence in the stock market’s long-term performance, you can go for Schwab’s more aggressive strategy. On the other hand, if you happen to have a low risk appetite, the Vanguard fund would be the better option because of its lower allocation to stocks.


Understanding the ‘Good’ and ‘Bad’ of Historical Performance


In 2014, the S&P 500 index had excellent returns with the index up 13.69%. The next year was more challenging and volatile for investors, with the Index returning only 1.4%. Out of the three funds, the top performer in 2014 was the Vanguard fund (7.19%), followed by the Schwab fund (6.65%) and the Fidelity fund ( 5.75%). However, during the more trying 2015 year, the best performing fund was Fidelity’s (-0.20%), followed by Schwab’s (-0.40%) and Vanguard’s (-1.72%).

The pattern suggests that asset allocation policy along with active and/or passive management strategies played a crucial role in explaining the performance differences. For instance, the Fidelity fund was able to restrict its downside in the volatile year yet underperformed in the up year, suggesting that the glide path might be of a more conservative nature.

This brings out yet another aspect of these funds that investors need to perform, i.e. proper due diligence. Doing so can help an investor have a complete picture of the chosen target-date fund as they will be encouraged to monitor and compare fund performances during both the good years and the bad. In this context, you might want to read more about the due diligence procedures of a target-date fund.


Understanding and Monitoring the Glide Path


It is also crucial to analyze the fund’s investment strategy and whether it follows an active, passive or hybrid approach. In our example above, the Vanguard fund is comprised of four index funds that are designed to mirror an index. The Fidelity fund is comprised of several actively managed funds, of which each has its own track record. In this context, it becomes important to take note of historical performance. For active management, prior performance of the fund in good and bad years should guide your future expectations; while for passive management, it’s important to keep tracking error over time and conduct peer comparison.

Understanding the fund’s glide path will help you to decide if the fund is capable of helping you achieve your investment goals. For example, will a portfolio of 70% bonds be enough to sustain your retirement spending capacity after the age of 73? Or does the glide path meet your risk tolerance needs, especially during the early years when the portfolio is invested primarily in stock?

Before you jump into choosing a target-date fund, you should factor into your analysis how the fund’s glide path is supposed to be managed over time, whether passive/active strategy adopted by the fund is right for you and what portion of your target-date fund should be actively/passively managed.


The Bottom Line


However, be aware of the fact that not all target-date funds are made the same due to the different investment strategies of each fund company. Some are passive, like Vanguard’s or actively managed, like Fidelity’s.

Be sure to follow our Target-date Funds section to make the right investment decision.

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