Originally posted at Cake Financial.
Nascent, but maturing, Target-Date Funds now demand more scrutiny. Both The Wall Street Journal and Barron’s gave these funds-of-funds, also called Lifecycle Funds, a once over this week without hitting on obvious faults and room for improvement.
According to ICI, assets in Target-Date Funds grew to $183 billion in 2007 from just $15 billion at the end of 2002. That’s 1133% asset growth compared to 88% asset growth for all non-money market mutual funds over the same period. Minute compared to over $12 trillion in all U.S. long-term mutual funds, a shift is clearly on into fund-of-fund products.
The industry has itself a winner, but I still cant figure out why or how. Asset allocation is all over the map for funds with similar retirement dates. The articles point out discrepancies in short-dated funds (2020) in which the Wells Fargo Advantage Dow Jones Target 2020 Fund is 58% invested in stock and the AllianceBernstein 2020 Retirement Strategy fund is 80% in equities. Then Barron’s points to SunAmerica 2020 High Water Mark C, with a 2.3% expense ratio holdings 50% CASH!
For the right people, Target-Date Funds are better than nothing. And, in fact, companies are using these funds for default 401(k) investments following the 2006 Pension Protection Act. Still, I was surprised to read in Barron’s that target funds represent 20% of 401(k) plan assets.
The pricing structures for these funds sound a bit screwy. Vanguard quotes an expense ratio that is the weighted average of the underlying funds. There are some funds, however, that charge a premium for the asset allocation decisions. Never mind that the Target-Date Funds are simply another asset funnel into a fund company’s own sometimes inferior products.
My 401(k) option includes Fidelity Freedom Funds. I would be in line for the Fidelity Freedom 2040 option. The fund is 67% U.S. stock, 18% non-U.S. stock, 5.2% investment grade bonds, 10.1% high-yield bonds and 0.1% other assets. While I may like the underlying fund selections (I don’t), youd’ think that Fidelity might make their Target-Date product essentially an asset allocation recommendation engine and then allow the user to pick funds around that.
I might dial up non-U.S. stock. Swap out a few U.S. stock funds and tone down high-yield. The 401(k) plan does not make that easy. You have to go through Fidelity’s Brokerage Link, which means you have to hold non-plan funds in an account within the 401(k), complicating some of the simplicity of the account.
For those who do like the asset mix in a Target-Date Fund, but want more of one fund or another, you can simply buy it outside the Target-Date Fund and make your own allocation. Like the asset mix in a younger fund but don’t want as much risk? Hold cash or a stable value fund to minimize the equity risk.
Education around such options is not provided, but if the industry truly wants to make these products more user friendly, perhaps it should be.
