The emergence of the target date fund has been one of the best developments for retirement savers. Whereas many workers were once paralyzed by the thought of building a well-balanced retirement portfolio on their own, they can now, in many cases, simply choose a target date fund in their 401(k) and get the benefits of professional management, diversification and automatic portfolio rebalancing all in one spot without the hassle of having to manage and maintain their investments.
But target date funds are not created equal. The asset allocation of such a fund is dependent entirely on the decision making of the fund provider. While funds may share a similar target date, they may have significantly different allocations making some funds riskier than others. Some savers during the financial crisis found out this lesson the hard way. They thought their portfolios were invested conservatively as they neared retirement only to find that many were still heavily invested in stocks. The AllianceBernstein 2010 Retirement Strategy fund was a few years away from its anticipated target date but was still about ⅔ invested in equities. The fund dropped over 32% in 2008. Granted, that was the financial crisis and just about anything related to equities lost money around that time but a healthier allocation to bonds and cash so close to the target date would have been much less painful for shareholders who had to delay retirement.
Shareholders of 2020 target date funds are in the same position right now. We're at the tail end of the greatest fixed income bull market in history and have seen the S&P 500 rise for eight straight years. It's easy to feel like the good times will continue but now is the time for near-retirees to focus on preserving what they have instead of trying to chase higher returns. In short, it's time for a portfolio checkup. It's time to see what's in those 2020 target date funds to make sure it's consistent with where these folks should be invested.
Thankfully, the financial crisis was something of a wake-up call to get fund managers to get their funds' asset allocations back in check and now most are reasonably in line with generally accepted guidelines for this age group. You can't assume all 2020 target date funds are equal because, again, each one can have a different asset allocation, so it's important to take a look under the hood to see what's actually in your fund.
I'm going to examine 14 of the largest 2020 target date funds in the marketplace to check out their allocations to make sure shareholders aren't at undue risk. The list of funds include the following...
American Century One Choice 2020 Portfolio (ARBVX)
American Funds 2020 Target Date Retirement (AACTX)
BlackRock LifePath Index 2020 (LIQAX)
Fidelity Freedom 2020 Fund (FFFDX)
JPMorgan Smart Retirement 2020 Fund (JTTAX)
MainStay Retirement 2020 Fund (MYROX)
MFS Lifetime 2020 Fund (MFLAX)
Putnam RetirementReady 2020 Fund (PRRMX)
Schwab Target 2020 Fund (SWCRX)
T. Rowe Price Retirement 2020 Fund (TRRBX)
T. Rowe Price Target 2020 Fund (TRRUX)
TIAA-CREF LifeCycle 2020 Fund (TCLTX)
Vanguard Target Retirement 2020 Fund (VTWNX)
Wells Fargo Dow Jones Target 2020 Fund (WFLPX)
A few quick ground rules first. I'm looking at the actual asset allocations of the fund, not the target allocations. In most cases, they're close or identical but in a few they're a little off. Second, if a fund is labeled as a domestic bond fund, for example, I'm counting all assets in the domestic bond bucket. I realize it may have 1% of its assets in foreign bonds but I'm not digging in that granularly. Only when there is a notable mix of asset classes did I separate them out (I had to do this with the Putnam fund).
With that being said, let's take a look at the asset allocations for these funds. As you're about to see, there's quite a bit of variance in how managers feel assets should be invested.
American Century One Choice 2020 Portfolio
For the record, generally speaking I think a 65 year old retiree should be about 40-50% in equities, depending on their tolerance for risk. The allocation of this fund looks pretty good. The 20% allocation to foreign securities is a nice addition and should help balance out the fund's overall risk.
American Funds 2020 Target Date Retirement
The fund is tilted a little heavier towards equities but isn't really out of whack. I don't see anything wrong with this fund's allocation although the 21 funds within the portfolio and the 0.72% expense ratio leave something to be desired.
BlackRock LifePath Index 2020
The 44-55-1 distribution of funds seems right about where a 2020 target date fund should be. It has an appropriate allocation to foreign securities and one of the lower expense ratios in its peer group. I think this is one of the better 2020 funds available.
Fidelity Freedom 2020 Fund
I find it a bit concerning that one of the biggest and most well known names and one of the biggest funds in this group has an asset allocation so that's so out of whack. Having nearly ⅔ of the fund's assets in equities just a few years from retirement is too much, especially considering factors such as the changes in the executive branch, the impact of Brexit, the relative valuation of the markets, foreign relations and rising rates. The risk of this portfolio needs to be pared back.
JPMorgan Smart Retirement 2020 Fund
This fund follows the same general blueprint as many of the others. About 50% invested in equities and 20% invested overseas with a small cash position. I don't see any issues here. The 0.81% expense ratio is a little on the high side.
MainStay Retirement 2020 Fund
It's a little harder to judge the allocation on this one since the fund says it is targeted to those "seeking to retire between the years 2016 and 2025". That's a big window. The allocation is probably fine for someone retiring in 2025. For those retiring right now, the 54% in equities might warrant a bit more caution.
MFS Lifetime 2020 Fund
This fund has one of the more conservative allocations of the bunch with just ⅓ of the portfolio invested in equities. The fund has good quality characteristics - the equity portion is essentially a Russell 1000 clone while the fixed income portion is largely made up of government and agency issues. More risk averse investors will appreciate this fund but it might be too conservative for others.
Putnam RetirementReady 2020 Fund
Here's another fund with an excessively conservative allocation. While the fund advertises a 6% position in cash, once you add in the cash positions of the underlying funds you're up to almost 20%, easily the highest number in this bunch. Couple this with the smallest equity allocation of the bunch and you have a fund that should probably be more aggressive.
Schwab Target 2020 Fund
Many of Schwab's funds are known for their rock bottom expense ratios but this one only falls in the middle of the pack. The asset allocation is just right though and this fund should be near the top of the list of folks seeking a 2020 target date fund.
T. Rowe Price Retirement 2020 Fund
This fund is starting to creep towards the "too aggressive" end of the spectrum with its 60% allocation to equities and 30% investment overseas. It's hard to argue with the performance though. Morningstar gives it a 5-star rating across all time frames.
T. Rowe Price Target 2020 Fund
I'm not exactly sure how T. Rowe Price's Retirement 2020 Fund differs from its Target 2020 Fund other than it's a much smaller version with a similar objective and a different allocation. That aside, the 48% allocation to equities seems more appropriate for 2020 retirees than the fund above. This is a good allocation overall.
TIAA-CREF LifeCycle 2020 Fund
TIAA-CREF has one of the more equity heavy portfolios in this group but the overall allocation doesn't necessarily seem out of line. The fund is invested heavily in large cap income names and Treasury securities which should help mitigate some of the risk.
Vanguard Target Retirement 2020 Fund
Known for its conservative management style, Vanguard actually has one of the more aggressive 2020 funds available. Its 57% allocation to equities is 3rd highest of the 14 funds and its 35% investment overseas is easily the highest. The fund's 0.14% expense ratio will always keep it a step ahead of its peers shareholders in this fund should be aware of what they're buying into.
Wells Fargo Dow Jones Target 2020 Fund
And we finish with one of the most conservative funds in the group. The 30% allocation to equities is the 2nd lowest and well below the 50% median of the group. This fund should ideally be closer to 40% although the mix of domestic and foreign investment looks pretty good.
For those looking for all the funds side by side, here's the graphic.
With a range of 29% equity all the way up to 64%, this exercise demonstrates exactly why 1) not all target date funds are created equal and 2) you shouldn't choose a target date fund based on a year alone.
Of the 14 funds analyzed, I'd rate three (Vanguard, Fidelity and T. Rowe Price) is too aggressive and three (Putnam, MFS and Wells Fargo) as too conservative. The remaining eight funds look like they're right where they should be, generally speaking.
My primary concern looking at the results is that Fidelity and Vanguard, two companies whose 2020 target date funds account for $40 billion in investor money, are invested in a riskier manner than I'd feel comfortable with given the close proximity to retirement for its investors. Target date funds aren't meant to be invested in blindly in the first place. Looking at the differences between these 14 funds should make that fact even more apparent.
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Disclosure: I/we have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.