Retirement Date Funds are known by a couple of different names such as age based funds, life cycle Funds, etc., but they are all based on the same idea that the fund (either mutual fund or ETF) will reallocate itself based on the chosen retirement date. They are meant to be a maintenance free and thought free way to passively reallocate over time.
For most they are probably a fantastic way to invest in the market knowing someone else is worrying about allocation, however, for me they just don’t make all that much sense.
Comparing Two Life Cycle Funds from the Same Company
I think the easiest way to understand the concept is to take a look at two funds from the same company, Vanguard.
Vanguard Target Retirement 2045 Fund (VTIVX)
Portfolio composition – Allocation to underlying funds as of 08/31/2013
Ranking by Percentage Fund Percentage
- Vanguard Total Stock Market Index Fund Investor Shares 63.0%
- Vanguard Total International Stock Index Fund Investor Shares 26.8%
- Vanguard Total Bond Market II Index Fund Investor Shares† 8.2%
- Vanguard Total International Bond Index Fund Investor Shares 2.0%
Total — 100.0%
Vanguard Target Retirement 2015 Fund (VTXVX)
Portfolio composition – Allocation to underlying funds as of 08/31/2013
Ranking by Percentage Fund Percentage
- Vanguard Total Stock Market Index Fund Investor Shares 37.1%
- Vanguard Total Bond Market II Index Fund Investor Shares† 32.4%
- Vanguard Total International Stock Index Fund Investor Shares 15.9%
- Vanguard Total International Bond Index Fund Investor Shares 9.4%
- Vanguard Short-Term Inflation Protected Securities Index Fund Investor Shares 5.2%
Total — 100.0%
A quick look at the allocation you can see the differences. The person retiring in 2 years has a higher allocation towards “safer” investments. Bonds are 41.8% vs. 10.2% and Short term Inflation Protected Securities are at 5.2% vs. 0%. The idea is that as we get closer to the 2045 date it will look more like the 2015.
Wait so someone else does the work, why isn’t this a good thing?
Why I am not a big Proponent of Life Cycle Funds
Doesn’t take into account Current Market
Selling out of the stock market and getting into bonds should be a bigger decision than just hitting a date. For example, if you sold out of the market today and jumped into a bond fund it could have disastrous results if you believe interest rates are set to rise over the next couple years.
Age Based Funds are Expensive
Since they are traditionally a fund of funds you are not only paying the expenses on the fund you buy into but the funds it holds as well. With the low fees at Vangaurd you are probably way ahead anyway when compared to other investing options, but that may not be true across the board. For instance the Vanguard 2020 Retirement fund has an expense ratio (not including the funds it holds) of .16% while the Fidelity 2020 Fund has an expense ratio 4x that amount at .65%.
There is No Uniform Allocation
There are no uniform allocation rules (nor should there be), but this may be a problem for the investor purchasing the investment. This isn’t the fault of life cycle funds themselves, per se, but rather the individual investor. Lets stick with the Fidelity 2020 vs Vanguard 2020:
Vanguard Portfolio composition as of 08/31/2013
- Vanguard Total Stock Market Index Fund Investor Shares 43.6%
- Vanguard Total Bond Market II Index Fund Investor Shares† 30.3%
- Vanguard Total International Stock Index Fund Investor Shares 18.5%
- Vanguard Total International Bond Index Fund Investor Shares 7.6%
Versus
Fidelity 2020:
- Equity Funds – 35.31%
- Commodity Funds – 5.61%
- International Equity Funds – 14.49%
- Bond Funds -37.37%
- Short-Term Funds & Net Other Assets – 7.22%
- NET OTHER ASSETS -0.07%
The two “similar funds” have different allocations. Vanguard has 62.1% in Equities while Fidelity is 49.8%. Those are very different risk tolerances for people retiring in 2020. Again this isn’t the fault of the fund, but of investors who need to understand what they are buying and a lot of people just don’t.
Would I Put a Friend or Family Member into a Life Cycle Fund?
Absolutely. How do I reconcile my feelings? If they don’t want to get involved in reallocating themselves then the above negatives are outweighed.
Totally agree. May work for some, but right now at least I desire a more nuanced approach.
They are 100% better than doing nothing but just the tiniest bit of work can go a long way for someone! Even if its just buying an index fund and bond fund and reallocating yourself.
I have the Vanguard 2045. I did read that during the 2008 financial crisis a lot of the target retirement funds were too risky. I’ve thought about using Vanguard’s life strategy funds instead, but I’m okay with the allocation for now.
With vangaurd the double fees are probably just not a big deal, but what about allocating it yourself?
I like that you pointed out that target date funds are expensive relative to the cost of the underlying funds. I prefer to handle my allocation myself and save the additional fund expense. Some target date funds (from Schwab for example) even have actively managed funds in them, that really adds on to the fee.
Wow throw in an actively managed mutual fund and you can get into the 2%+ world! Might as well buy an annuity and at least get some downside protection.
I’m kind of confused. The title says ETFs, but it seems like you are writing about mutual funds. I realize it’s the same concept, but I was curious for three reasons why ETFs are particularly bad for retirement date funds.
Sorry you are right! The post is really about both ETFs and MFs not one versus the other. I changed the title appropriately.
The reason I don’t care for them, is one of the reasons you listed: They don’t take the current market into consideration. But like you said, it’s better then not doing anything at all.
Anything is better than nothing!
Uh huh… I’ve kind of intuited something along those lines, even tho’ I’m not clever enough to articulate it as clearly as you have.
Anything that’s even vaguely knee-jerk, as these things seem to be, makes me kinda nervous.