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What Are Retirement Target Date Mutual Funds?

The advantages, limitations, and key considerations of retirement target date funds.

Many of the mutual funds available to U.S. investors offer exposure to exotic asset classes or sophisticated stock picking strategies. At the far other end of the “complexity spectrum” are retirement target date funds, a unique segment of the fund market that has become popular among investors embracing simplicity and low fees.

Retirement target date funds may seem too broad and basic to be useful. For some investors, that may be the case. But for others looking to take ownership of a modest portfolio, they can be very powerful tools and effective building blocks.

How do retirement target date funds work?

There are two key structural aspects of retirement target date funds. Firstly, these products are typically structured as “fund-of-funds,” which means that their holdings typically consist of other mutual funds. So, while a retirement target date fund is only a single security, it effectively offers investors access to a diversified underlying basket of stocks and bonds.

As an example, consider the Vanguard Target Retirement 2030 Fund (VTHRX). This fund holds four mutual funds, which in turn hold nearly 10,000 stocks and 12,000 bonds from dozens of countries around the world:

So an investor who owns VTHRX effectively owns more than 21,000 stocks and bonds, with no single security making up more than 1 percent of the portfolio.

The second noteworthy feature of retirement target date funds is the fluid nature of the holdings. As investors approach retirement, they typically lower allocations to stocks and increase allocations to bonds. An effective retirement target date fund adjusts its portfolio to mirror the changing risk tolerance of investors.

For example, a 2055 retirement target date fund may allocate 90 percent of its holdings to stocks today; an investor expecting to retire in about 40 years would have a fairly high risk tolerance. Over time, as 2055 gets closer, the asset mix will shift towards bonds until stocks represent only about 25 percent of the total.

The following image shows one possible glide path of assets from a young investor to a retiree:

Image Source: Vanguard

Are retirement target date funds a realistic strategy?

At a time when financial markets seem increasingly sophisticated and investing is often presented as an extremely complex activity, retirement target date funds may seem like quaint, outdated products. But the beauty of these funds is in the simplicity. And they are becoming more popular as effective tools for self-directed investors looking to take greater control of their portfolios.

In other words, it is perfectly reasonable for many investors to have almost all of their assets in a single target date fund. In fact, for many investors this will be the ideal approach for several reasons:

  1. Simplicity: A target date fund is about as simple as a portfolio gets. For those who don’t understand investing jargon and some of the more complex concepts, there is a certain appeal in a fund with a very simple, clear objective.
  2. Automation: Retirement target date funds handle rebalancing, risk adjustment, and other administrative issues that can take up time or drag on a portfolio if overlooked.
  3. Temptation: When investments are spread across multiple funds in different asset class, investors will inevitably be tempted to tweak the allocations based on the latest movements in the markets and various other influences. With a single target date fund, however, much of this temptation is avoided.

A better illustration perhaps comes in the form of a performance chart. The following shows how the Vanguard 2025 Target Retirement Fund (VTTVX) would have grown for an investors who contributed $1,000 each month starting in late 2003 (when VTTVX launched):

What are the limitations of retirement target date funds?

Below are some potential drawbacks or limitations to retirement target date funds that investors should consider.

  1. Volatility: Retirement target date funds are by no means a smooth ride. Some of these funds allocate 90 percent or more of assets to stocks (specifically, those multiple decades away from retirement). These funds may experience drawdowns of 30 percent or more in a single year. Over the longer term (multiple decades), however, retirement target date funds can be expected to deliver steady returns.
  2. Other Factors: Retirement target date funds determine the asset allocation strategy based on a single number: years until retirement. This process is typically a bit more complex; other factors that influence asset allocation strategies include income and level of wealth.
  3. More Expensive: Retirement target date funds are often more expensive than building a “do-it-yourself” portfolio consisting of the underlying funds. It is possible, however, to find very cost efficient target date funds (more on this below).

Which are the best retirement target date funds?

In a word: Vanguard.

Most issuers offer a lineup of retirement target date funds, typically consisting of other funds from their lineup. Vanguard retirement target funds are by far the cheapest options; most cost less than 0.25 percent annually.

As a comparison, the average mutual fund charges about 1.3 percent annually. Among all retirement target date funds, the average is 0.94 percent. For investors planning to buy-and-hold a retirement target date fund for an extended period of time, fees become critical.

The following assumes a 5 percent gross annual return, and shows how a fund with 0.20 percent in fees would fare relative to a fund that charges 0.94 percent:

Retirement target date funds certainly have some drawbacks. But they can be very useful tools for self-directed investors looking to implement a low cost, simple strategy for the long term. If you’d like to learn more about retirement target date funds and other mutual fund investing basics — including how to construct a low-cost mutual fund portfolio — read our free report, The Beginner’s Guide to Mutual Funds.

About the Author: Andy Hagans

Andy Hagans is editor in chief for Fund Reference, and also serves as CEO of parent company Poseidon Financial. He is passionate about the “Bogleheads” school of investing, and is focused on helping investors achieve higher net returns via tax efficiency and fee minimization. He resides in southwest Michigan.


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