Not All Target Date Funds Are Created Equal

If you’re a retirement plan investor or just someone who’s looking to sock a little money away for a later time, you may have already found out that target date mutual funds are rapidly gaining in popularity.  Target date funds, also known as life-cycle funds, are investments that are managed with a specific time frame in mind.  Consider, for example, the Vanguard Target Retirement 2040 Fund.  This fund is managed for someone who currently has a goal about 30 years out.  Right now, it maintains a stock-heavy portfolio but progressively becomes more conservative as the year 2040 approaches.

Target

Considering that many of the major fund companies like Vanguard, Fidelity, T. Rowe Price, Schwab and Wells Fargo now offer similar 2040 funds, you might think that they’re all essentially the same and the only difference is perhaps the expense ratio that the fund charges.  You would be very wrong.

These funds can differ as far as the asset allocations they maintain at certain points throughout the life of the fund to the actual investments held within the funds themselves to the way that they are managed.  Let’s do a quick comparison of the Vanguard Target Retirement 2040 Fund and the Fidelity Freedom Fund 2040.  Both funds look the same based on their name but it’s time to dive deeper.

And the differences start right at the top.  The Vanguard fund currently maintains a 90% stock-10% bond allocation.  The Fidelity fund on the other hand has a more conservative 83% stock-17% bond allocation.  It’s not a huge difference but it is significant enough that it can make a dent in your long-term returns especially if you think you’re getting the same thing in either fund.

The content of that stock allocation is different between the two funds as well.  Of the 90% stock allocation in the Vanguard fund, 18% is invested in international stocks.  At Fidelity, 22% of the 83% stock allocation goes to overseas investments.  Again, it’s not a huge difference but enough that it can make a difference over the years.

You also want to look at how your funds will be invested over time too.  In 2040, the Vanguard fund will maintain a 30% allocation to stocks.  At Fidelity, you’ll find your money invested in a much more aggressive 50% stock allocation.  That could be a big difference.  A 50% allocation to stocks could still wreak havoc on your account balance as you near the point where you’ll need the money especially if you think your money will be invested conservatively when you need it.

The moral of the story is to know what you’re investing in.  In the case of target funds, you’d be wise to make sure that the asset allocations of the fund match up with how much risk you’re comfortably willing to take instead of choosing a fund based on the date in its name.  Often times, it comes down to a difference in management styles.  Some managers like to be more aggressive.  Both the Vanguard and Fidelity funds rely on other funds within the fund family for investment but some will dabble in individual stocks which can alter the fund’s risk profile as well.

As with any investment, knowing what you’re putting your money into lessens the possibility of being surprised or disappointed down the road.  And with little time to make up losses when the fund comes due, that’s exactly what you need.

Photo credit: Melissa Gray

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Author Info

This post was written by David Dierking. David lives outside Milwaukee, Wisconsin and has been working in the financial services industry for over 13 years with a background in investments, accounting, and marketing. He earned his Chartered Financial Analyst designation from the CFA Institute in 2004 and was recently published in the Milwaukee Business Journal. You can also check him out at The Ultimate Fit Challenge

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