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Dig Deep When Using Target-Date Funds

Roger Wohlner

As of March 2012, nearly 25 percent of all 401(k) participants were invested in a target-date fund as their only investment holding. This represented a six-fold increase in six years according to Vanguard via research for plans they manage. Their research went on to say that 64 percent of new plan participants entering a plan for the first time contributed 100 percent to a single target-date fund.

Much of the growth in target-date funds has been driven by the Pension Protection Act of 2006 which approved the use of such funds as a default option for 401(k) plan sponsors, who are allowed to automatically select them for participants who do not make their own choices. These funds are big business for the fund companies offering them not only within 401(k) plans, but as they push for the 401(k) rollover business when participants leave their employers.

The plan providers and fund companies portray these funds as an easy, one-decision investment. Invest in the fund with a target date closest to your anticipated retirement date, they say, and leave the rest to us.

But when you invest in a target-date fund where is your money really going? A look at similar funds from the three biggest providers offers a few insights into the philosophies and differences in approach. For example:

Fidelity uses 23 underlying mutual funds; T. Rowe Price uses 19; Vanguard uses five.

Fidelity and T. Rowe Price focus on actively managed mutual as the underlying investments, while Vanguard uses passive index funds. And that can impact how much the funds cost you.

The expense ratio for all three groups is comprised of a weighted average of the underlying mutual funds in each of the target-date funds. For Fidelity the average was 0.64 percent; T. Rowe Price 0.70 percent; Vanguard 0.18 percent.

Vanguard and T. Rowe Price use the same underlying funds that are generally available to investors. Fidelity has moved in large part to the use of their Series funds, a group of institutionally managed funds designed for use only in their target-ate funds. Fidelity has indicated that it is considering adding funds for use in their target-date series managed by star managers such as Will Danoff and Joel Tillinghast who manage Fidelity Contrafund and Fidelity Low-Priced Stock, respectively.

Glide path is a key term in the target-date fund world. This refers to the decline and ultimate leveling out of the allocation to equities within these funds as shareholders "glide" into retirement. As you might expect, the glide path differs with each of these groups as well. T. Rowe operates on the longest glide path, ending at age 95. Fidelity's path ends at 80 and Vanguard's at age 72. As such T. Rowe's funds are generally a bit more aggressive as they're designed to produce returns for investors over a longer span of time. Another point about the glide path: fund companies assume that you will hold them through retirement and perhaps until death. You might or might not do this, if you don't the glide path does not make as much difference. All three fund series are "through" retirement rather than 'to" retirement. In the latter case the glide path would level off around age 65.

As far as the asset classes represented by the underlying holdings in the funds, Vanguard's approach is the most basic. They include domestic large-, mid-, and small-cap equity, developed and emerging market foreign stocks, and domestic fixed income including TIPs.

Fidelity and T. Rowe both include the asset classes listed above plus high-yield bonds, emerging markets bonds, real estate, and commodities. T. Rowe Price also uses developed foreign bonds. None of this is good or bad, but as with any investment you should be aware of how your money is being managed before committing your retirement savings.


As mentioned above target-date funds are frequently used as the default option for 401(k) participants who don't specify an investment choice. As far as choosing which family of funds to use, 401(k) participants generally won't have a choice; their employer makes that decision as plan sponsor.

Besides the fund of proprietary funds approach used by these three families, there are target-date funds using ETFs and other vehicles as the underlying investments. Should you go the target date route? Here are a few factors to consider:

--Are you comfortable allocating your retirement account from among the other options available in the plan?

--Are there advice options available to you via your retirement plan? These might include online help, in-person meetings or managed account options.

--Do you work with a financial adviser on your accounts outside of the plan? If so, the adviser might be in a position to provide advice on your 401(k). In any event these assets should be considered by your adviser in the course of the advice they provide to you.

If you decide that a target-date fund is right for your situation, remember to choose the fund that best fits your unique situation; this may or may not be the fund with the target date closest to your anticipated retirement date. Also remember that using a target-date fund does not guarantee retirement savings success. The biggest determinant here is the amount saved during your working life.

While I'm not a huge fan of these funds, they can be a sound alternative for many 401(k) investors. Make sure you have researched this and all options available via your 401(k) plan to determine if this is truly the best option for you.

Roger Wohlner, CFP®, is a fee-only financial adviser at Asset Strategy Consultants based in Arlington Heights, Ill., where he provides financial planning and investment advice to individual clients, 401(k) plan sponsors and participants, foundations, and endowments. Roger is active on both Twitter (@rwohlner) and LinkedIn. Check out Roger's popular blog The Chicago Financial Planner where he writes about issues concerning financial planning, investments, and retirement plans.

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