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Taking Aim at Your Retirement: A Look at Target Date Mutual Funds

by John Markese

Taking Aim At Your Retirement: A Look At Target Date Mutual Funds Splash image

There is an appealing simplicity in the concept of target date funds that has a strong attraction for investors: Just pick a year, and lean back—your portfolio management is now on autopilot, with coordinated diversification among the major asset classes that is rebalanced periodically toward your estimated time of arrival, your target date.

But while the concept of the target date fund has a justified appeal to a broad range of investors, making the right choice among the many target date fund offerings and understanding how the funds work is not quite as simple as it appears at first glance.

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John Markese is the former president of AAII.
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The Risk/Growth Dilemma

Target date funds are built on the assumption that investors who are farther from their target retirement date should have higher allocations to stocks, and that the stock commitment should decrease as the target date approaches. Thus, funds with an earlier target date will start out with a lower stock allocation than funds with a later target date, but all of the target funds within a family will decrease their commitment to stocks as the target date approaches.

When the target date arrives, the asset allocations resemble a portfolio suitable for a retirement period that may extend for decades. This terminal target date portfolio will have substantially less risk than a target date fund with 40 years to run before the target date, and it will also have a significant income emphasis rather than the growth emphasis of a distant target date fund.

However, the portfolio composition at the target date confronts a familiar dilemma: How should the conflicting goals of low-risk investment in retirement be balanced against the need to incorporate into the portfolio some stock investments that, although higher risk, will serve to outpace inflation?

The practical implications of this risk/growth trade-off, particularly for investors nearing retirement target dates or in the years just after the retirement target date, become real with a sudden and significant drop in worldwide stock prices. Withdrawing money from the stock portion of a retirement portfolio when stock prices are depressed can have lasting negative implications for the sufficiency of assets to last the lifespan of the investor. Even if you manage to pick the right target date, sometimes decades before the event, target funds are not without uncertainty.

Choosing Among Funds

And then there is the decision to be made—among the increasing number of offerings of target date mutual funds—of a specific fund.

The target date mutual fund offerings are dominated by Vanguard, Fidelity, and T. Rowe Price, with funds available also from Schwab and American Century.

All of these funds invest in the broad-based mutual funds of their respective fund family—they are, in essence, funds of funds. However, the mix of mutual fund holdings varies based on the target maturity date. And all of these target date fund families agree on one particular concept: There is a progression among the target date funds that goes from an asset mix that favors stock and is more volatile (for the farthest target dates) to an asset mix that is less volatile and stresses more fixed-income investments (for the more current target dates and the income funds).

However, the steps along this path, and the mix of assets in the portfolio at any one step, can and do vary by mutual fund family. Here is where the simple concept of the target date fund can get a bit more complex—and this is where investors need to take the controls and pay attention to the flight plan.

Table 1 lists all the major target date fund offerings. It groups target date funds by fund family, and within each group it lists the funds based on the target date, from the nearest date to the most distant.

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Table 1. Asset Allocations of Target Date Funds

   
 
 
 
Symbol
 
Allocation of Fund Holdings
  Domestic
Stocks
(%)
Foreign
Stocks
(%)
Domestic
Bonds
(%)
Foreign
Bonds
(%)
Money
Markets/
Cash
(%)
Other
(%)
 
 
Fund Name 
American Century
LIVESTRONG Income ARTOX 39.0 5.0 38.0 7.0 10.0 1.0
LIVESTRONG 2015 ARFIX 42.5 7.3 36.2 5.8 7.0 1.3
LIVESTRONG 2020 ARBVX 45.5 9.3 34.2 4.5 5.0 1.6
LIVESTRONG 2025 ARWIX 49.2 11.3 30.7 2.0 5.0 1.8
LIVESTRONG 2030 ARCVX 53.5 13.0 27.0 0.0 4.5 2.1
LIVESTRONG 2035 ARYIX 58.4 14.3 23.1 0.0 2.0 2.3
LIVESTRONG 2040 ARDVX 62.3 15.5 19.6 0.0 0.0 2.6
LIVESTRONG 2045 AROIX 63.7 16.3 17.2 0.0 0.0 2.8
LIVESTRONG 2050 ARFVX 66.0 16.0 15.0 0.0 0.0 3.0
Fidelity
Freedom Income FFFAX 18.2 0.0 40.4 41.4
Freedom 2000 FFFBX 21.0 0.3 37.4 41.3
Freedom 2005 FFFVX 35.1 8.2 41.5 15.2
Freedom 2010 FFFCX 36.9 9.9 42.7 10.5
Freedom 2015 FFVFX 38.8 10.5 42.4 8.3
Freedom 2020 FFFDX 48.7 12.9 37.1 1.3
Freedom 2025 FFTWX 52.5 14.0 33.4 0.1
Freedom 2030 FFFEX 60.1 15.9 23.9 0.1
Freedom 2035 FFTHX 62.6 16.5 20.8 0.1
Freedom 2040 FFFFX 64.9 17.0 18.0 0.1
Freedom 2045 FFFGX 65.4 17.3 17.2 0.1
Freedom 2050 FFFHX 67.3 20.7 11.9 0.1
Schwab
Retirement Income SWARX 15.4 5.0 54.4 5.0 20.3
Target 2010 SWBRX 35.5 14.6 38.3 4.2 7.4
Target 2015 SWGRX 41.3 18.2 32.3 3.3 4.8
Target 2020 SWCRX 43.6 19.3 31.3 3.6 2.3
Target 2025 SWHRX 48.7 21.3 22.6 2.6 4.8
Target 2030 SWDRX 47.7 22.0 25.3 2.9 2.2
Target 2035 SWIRX 53.9 23.5 17.4 2.1 3.2
Target 2040 SWERX 52.8 24.8 17.9 2.1 2.4
T. Rowe Price
Retirement Income TRRIX 32.2 8.4 52.9 3.2 3.2 0.1
Retirement 2005 TRRFX 39.2 10.2 44.1 3.7 2.6 0.2
Retirement 2010 TRRAX 45.2 12.9 35.9 3.1 2.6 0.3
Retirement 2015 TRRGX 51.1 15.4 27.9 2.5 2.8 0.3
Retirement 2020 TRRBX 56.3 17.9 20.7 1.9 2.8 0.4
Retirement 2025 TRRHX 60.9 19.8 14.6 1.4 2.9 0.4
Retirement 2030 TRRCX 64.2 21.2 10.2 1.0 3.0 0.4
Retirement 2035 TRRJX 66.7 22.2 7.0 0.6 3.1 0.4
Retirement 2040 TRRDX 66.6 22.2 7.1 0.7 3.0 0.4
Retirement 2045 TRRKX 66.6 22.3 7.0 0.7 3.0 0.4
Retirement 2050 TRRMX 66.5 22.2 7.0 0.9 3.0 0.4
Retirement 2055 TRRNX 66.7 22.5 6.6 0.7 3.1 0.4
Vanguard
Target Retirement Income VTINX 23.6 5.6 65.7 5.1
Target Retirement 2005 VTOVX 31.5 7.5 58.3 2.7
Target Retirement 2010 VTENX 41.7 10.3 48.0 0.0
Target Retirement 2015 VTXVX 49.4 12.2 38.4 0.0
Target Retirement 2020 VTWNX 55.5 13.8 30.7 0.0
Target Retirement 2025 VTTVX 61.5 15.3 23.2 0.0
Target Retirement 2030 VTHRX 67.5 16.9 15.6 0.0
Target Retirement 2035 VTTHX 71.8 17.7 10.5 0.0
Target Retirement 2040 VFORX 71.7 18.1 10.2 0.0
Target Retirement 2045 VTIVX 71.9 17.7 10.4 0.0
Target Retirement 2050 VFIFX 72.0 17.9 10.1 0.0

This highlights the glide path over time, from a fixed-income emphasis in the nearest-term target date funds, to a high stock allocation in the distant target date funds. For example, the Vanguard Target Retirement 2010 has 52% total in stock and 48% in bonds. In contrast, the Vanguard 2050 fund has 72% in domestic stocks and 17.9% in international stocks, for a total of 89.9% in stock and 10.1% in bonds.

All of these target date funds have similar progressions, but vary the percentages in domestic versus international stocks or bonds versus cash (where cash translates to money market mutual funds, or similar short-term fixed-income investments).

For example, the T. Rowe Price 2030 fund allocates 85.4% to stocks (64.2% to domestic and 21.2% to foreign) while American Century LIVESTRONG 2030 allocates 66.5% to stocks (53.5% to domestic and 13.0% to foreign). In addition, some families include foreign bonds in the mix (American Century, Schwab and T. Rowe Price), while others do not. [Ironically, the families that do allocate to foreign bonds, which typically are viewed as riskier than domestic bonds, actually increase their foreign bond commitments as the target date approaches, since the overall bond commitment is increasing.]

These portfolio allocation variations among target groups will produce different risk and performance figures beyond the differences in the specific investments within the asset allocation categories.

What Exactly Is the “Target”?

A significant difference among the fund families centers on when these target funds finally touch down and become, essentially, income funds. Most investors would probably assume that the touch-down date is the target date of the particular fund. However, this is typically not the case.

All of the families offer a retirement income fund for investors who are beyond their “target” dates. However, within the Vanguard target date family, a target date fund’s allocations converge with the asset allocation of the income fund seven years after the target date is reached. Fidelity’s final touchdown is 10 to 15 years after the target date, T. Rowe Price’s is 30 years, and Schwab’s is 15 years.

Only the American Century funds are designed to touchdown to an income portfolio at the target date.

Investment Characteristics

Table 2 details the performance of these target date funds, along with information on yield, expenses and, importantly, risk.

Fund Name Ticker Annual Return (%) Total
Risk
Index
Yield
(%)
Expense
Ratio
(%)
 
 
1 Yr 3 Yr 5 Yr Notes
American Century
LIVESTRONG Income ARTOX -16.4 -1.7 na 0.15 4.0 0.76 At target retirement date, allocation is fixed to match Income portfolio, but the funds are not denoted as combined.
LIVESTRONG 2015 ARFIX -19.3 -2.6 na 0.17 3.9 0.8
LIVESTRONG 2020 ARBVX na na na na na 0.82
LIVESTRONG 2025 ARWIX -23.6 -4.4 na 0.2 3.3 0.85
LIVESTRONG 2030 ARCVX na na na na na 0.87
LIVESTRONG 2035 ARYIX -28.5 -6.4 na 0.24 2.7 0.9
LIVESTRONG 2040 ARDVX na na na na na 0.92
LIVESTRONG 2045 AROIX -31.5 -7.7 na 0.27 2.6 0.97
LIVESTRONG 2050 ARFVX na na na na na 0.94
                 
Fidelity
Freedom Income FFFAX -10.1 -0.6 1.5 0.1 3.7 0.49 10 to 15 years after target date is reached, fund mimics Income fund and is combined with that fund.
Freedom 2000 FFFBX -11.7 -1.1 1.4 0.11 3.9 0.51
Freedom 2005 FFFVX -21.4 -4.6 0.4 0.18 3.6 0.64
Freedom 2010 FFFCX -22.3 -4.9 0.3 0.18 3.7 0.65
Freedom 2015 FFVFX -23.9 -5.6 0.5 0.19 3.3 0.67
Freedom 2020 FFFDX -28.7 -7.5 -0.3 0.2 2.9 0.72
Freedom 2025 FFTWX -30.1 -8.2 -0.5 0.24 3.0 0.73
Freedom 2030 FFFEX -33.5 -9.8 -1.2 0.25 2.6 0.76
Freedom 2035 FFTHX -34.4 -10.2 -1.4 0.28 2.4 0.77
Freedom 2040 FFFFX -35.4 -10.7 -1.5 0.29 2.6 0.78
Freedom 2045 FFFGX -35.7 na na na 2.1 0.78
Freedom 2050 FFFHX -37.3 na na na 2.2 0.8
                 
Schwab
Retirement Income SWARX -8.6 -1.4 na 0.10 4.0 0.68 15 years after reaching the target date, allocation remains fixed at 20% stocks and remainder in money markets and fixed income. Fund should match Income fund allocation, but it is not denoted as turning into that fund.
Target 2010 SWBRX -21.2 -5.8 na 0.18 4.0 0.92
Target 2015 SWGRX -21.8 na na na 2.0 0.89
Target 2020 SWCRX -23.8 -7 na 0.21 3.4 0.92
Target 2025 SWHRX -23.6 na na na 2.0 0.92
Target 2030 SWDRX -26.2 -7.9 na 0.23 3.0 0.96
Target 2035 SWIRX -26.5 na na na 1.9 0.92
Target 2040 SWERX -28.3 -8.8 na 0.25 2.8 0.96
                 
T. Rowe Price
Retirement Income TRRIX -15.4 -1.9 2.0 0.15 3.9 0.55 30 years after target date is reached, allocation remains fixed at 20% stocks and remainder in fixed income. Fund is not denoted as either combining with the Income fund or mimicking it.
Retirement 2005 TRRFX -19.0 -3.2 1.9.0 0.18 3.8 0.58
Retirement 2010 TRRAX -22.7 -4.8 1.3 0.21 3.3 0.61
Retirement 2015 TRRGX -25.7 -6 0.8 0.24 3.2 0.65
Retirement 2020 TRRBX -28.4 -7.3 0.4 0.26 2.6 0.68
Retirement 2025 TRRHX -30.6 -8.3 0.0 0.28 2.3 0.7
Retirement 2030 TRRCX -32.3 -9.1 -0.3 0.3 2.1 0.7
Retirement 2035 TRRJX -33.0 -9.7 -0.6 0.3 2 0.72
Retirement 2040 TRRDX -33.2 -9.6 -0.6 0.3 1.9 0.73
Retirement 2045 TRRKX -33.2 -9.6 na 0.3 1.9 0.73
Retirement 2050 TRRMX -33.3 na na na 1.7 0.73
Retirement 2055 TRRNX -33.3 na na na 1.8 0.73
                 
Vanguard
Target Retirement Income VTINX -10.3 1.1 2.7 0.12 4 0.19 7 years after target retirement date, fund mimics Income fund, but it is not denoted as turning into that fund.
Target Retirement 2005 VTOVX -14.7 -0.7 2 0.15 4.4 0.18
Target Retirement 2010 VTENX -19.2 na na na 3.9 0.19
Target Retirement 2015 VTXVX -22.4 -4.2 0.7 0.2 3.8 0.18
Target Retirement 2020 VTWNX -25.3 na na na 3.3 0.19
Target Retirement 2025 VTTVX -28.1 -6.7 -0.4 0.25 3.5 0.18
Target Retirement 2030 VTHRX -30.9 na na na 3 0.19
Target Retirement 2035 VTTHX -32.6 -8.9 -1 0.28 3.3 0.18
Target Retirement 2040 VFORX -32.4 na na na 2.8 0.19
Target Retirement 2045 VTIVX -32.5 -8.9 -0.6 0.28 3.2 0.18
Target Retirement 2050 VFIFX -32.4 na na na 2.8 0.19
                 

Performance

The performances of these target date funds follow from their strategy. Not surprisingly, the most distant target date funds with the most stock exposure incurred the greatest losses in the recent down market, while funds with closer target maturities sustained smaller losses.

Over the last five years, the losses for these well-diversified target date funds were small, with the nearest target date and income funds providing positive returns over what was an extremely difficult time period for stocks.

Risk

The total risk index measures the relative return volatility of a fund over three years compared to all funds. The total risk index for the average fund is 1.00, with a risk index above 1.00 indicating greater than average risk. For example, a fund with a risk index of 1.50 would be 50% more volatile than the average fund, while a fund with a total risk index of 0.50 would only be half as volatile as the average mutual fund. An “na” in the total risk index column results if the fund has been in operation for less than three years, and therefore has an insufficient return basis to calculate a total risk index.

All of these target date funds have significantly low total risk indexes—with the highest only 0.30—due to their mix of domestic and international stocks and bonds, along with their holdings of money market funds. In addition, the total risk indexes for each fund within a family declines as the target date approaches. For example, the T. Rowe Price Retirement 2045 fund has a total risk index of 0.30, while the T. Rowe Price Retirement Income fund has a total risk index of only 0.15.

For risk comparison, the average large-cap stock fund has a total risk index of 1.04, foreign stock funds average 1.34, long-term general bond funds average 0.50, and international bond funds average a total risk index of 0.59. Combining different types of funds into a portfolio—the strategy of a target maturity fund—creates a lower total risk index than that of the riskiest of the individual funds.

Yields

As would be expected, the yields of these funds—interest and dividends after expenses divided by average net asset value—increase as the target date approaches maturity. Generally the highest yields are generated by the nearest-term target maturity funds, which have the highest concentration of fixed-income investments.

Currently, the retirement income funds are generating an average yield of 4.0% in spite of the very low current money market yields. The yield figure is particularly important for retirees dependent on portfolio income flows.

Expense Ratios

The expense ratio is expressed as a percentage of the value of fund investments, and expenses reduce return dollar-for-dollar. Since expenses are netted against income, higher expenses reduce total return, but reduce yield first.

Since all of these target date funds are, in turn, composed of mutual funds (in other words, these are funds of funds), the expense ratios are a dollar-weighted average of the expense ratios of the underlying funds plus, in some cases, an added administration fee. Stock funds have higher expenses than bond funds, and foreign investments are more expensive than domestic investments.

Vanguard’s target retirement funds have expense ratios that are, in some instances, only about a fifth as high as comparable target date funds from the other families. That’s because the underlying Vanguard funds are all index funds, which typically have very low expenses because they are not actively managed, but instead are designed to mirror the performance of an index such as the S&P 500 index of large-cap stocks.

Fidelity’s 2020 target fund holds 27 individual Fidelity funds, of which only one is an index fund and the others are actively managed. Vanguard’s 2020 fund holds five funds, all index funds.

Actively managed funds also trade more often and incur more transaction costs, which reduce total return.

And because actively managed funds trade more they tend to be less tax-efficient—something to consider if the target date fund is not going to be held in a 401(k), IRA or other tax-sheltered account.

Taking Aim

Having waded through these statistics and strategies, what is the final conclusion on target date funds?

A “take aim at a target date and invest” approach is simple to do and simple to maintain, and it is an all-in-one package. All these funds are well-diversified and have acted as expected according to their target dates and asset mixes: risk declined and income increased for all these target date funds as the target dates approached the current period. All are well-positioned for their mission of mimicking the general individual investor preference for less risk and more income at increasing ages.

However, one difficulty in investing in these funds is picking among the various fund family “final touchdown” strategies. Remember that the target date is not necessarily the time at which the fund turns into an income fund, and that the glide path of these funds and the landing point vary considerably.

If you want to err on the conservative side with respect to risk, a target date that is shorter than your actual retirement may make some sense. For example, if you have 40 years until your actual planned retirement date and the target fund you have selected does not touchdown into a retirement income fund until 10 years after the target date, the conservative play would be to select a retirement date target fund only 30 years in the future. This strategy might minimize the impact of an extreme stock market downturn on your portfolio value if one occurs just about when you hit retirement and intend to start withdrawing money to meet post-retirement needs.

These families of target funds are not identical in risk, return, yield, expenses, or strategy. So make sure you do your research before you invest.

The accompanying box lists the Web sites for these funds. If you take the time to get a good focus on your target, you are more likely to hit the bull’s eye at your retirement—or at least come close.

Target Fund Family Web Sites

American Century

www.americancentury.com
Click on Individual Investors, then Funds and Performance.

Fidelity

www.fidelity.com
Click on Mutual Funds under Top Links on the left side of the home page. The Freedom funds are listed with the Allocation and Specialized group.

Schwab

www.schwabfunds.com
Choose the Fund Performance or Prospectus and Reports tab; the target funds are listed under Asset Allocation Funds.

T. Rowe Price

www.troweprice.com
Click on Individual Investors, then Mutual Funds.

Vanguard

www.vanguard.com
Click on Personal Investors, then Vanguard funds and All-in-one funds.

John Markese is the former president of AAII.


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