Adam Zoll: We are talking about target-date funds as part of Morningstar's 401(k) Week special report. Joining me is Josh Charlson, a senior fund analyst with Morningstar.
Josh, let's look at a few fact-versus-fiction items when it comes to target-date funds. The first one, people may think all target-date funds are pretty much the same: fact or fiction?
Josh Charlson: That is fiction. This is something where you want to do your due diligence, even if you are being defaulted into a target-date fund [in your 401(k) plan]. We are going to see differences in target-date funds in the glide path, the asset allocation. You are going to see the biggest difference as these funds get closer to retirement.
When we talked about the 2045 or the 2050 funds, you are going to see a fairly narrow range of that equity allocation, anywhere from 85% to 95%, with a 90% average. When we get down to the funds that are close to retirement, a couple of years away from retirement, that range is more like from 20% to 60%, or even 65%. So there can be some really significant differences in how that will affect performance. You want to pay attention to that.
Zoll: Let's talk about which target-date series Morningstar likes in particular. Can you give us some names?
Charlson: We rate target-dates as a series, because we are looking at the whole collective of funds along the glide path. When we talk about more aggressive target-date series, more equity heavy, T. Rowe Price is one of the best. That's a Gold-rated series of funds.
Another that we like--particularly if you want to go for the lower-cost, passive approach to target-date funds--Vanguard is also Gold rated. It has a great asset allocation team, expert indexers.
If we are talking about a more conservative glide path that gets a little more conservative earlier as we get toward retirement, JPMorgan has a very good series, and American Century. Both are Morningstar medalists. ( Click here to see all Morningstar Medalist target-date funds.)
Zoll: Let's talk about price for a moment. I imagine that just like with regular mutual funds, price for target-date funds can run the gamut.
Charlson: There can be a wide range, and it can be very confusing in the retirement space. There are a lot of different share classes. We incorporate price as part of our ratings. So we do look at that very carefully. Vanguard is the lowest-cost provider. It's from an index perspective.
The other ones I named there are all fairly competitive from an active-management perspective. Depending on the size of your employer, that may cause it to be a little more expensive. Funds who use outside managers, outside subadvisors, can be a little more expensive. So there can be a trade-off. In general, we prefer a lower-cost series.
Zoll: Let's move on to our next fact or fiction: "Target-date funds guarantee I'll have enough money by the time I retire." Is that so?
Charlson: That's another fiction. And in fact, when the SEC did a survey of investors a few years ago, they found this was a common misconception. They are not any sort of guaranteed income product or any guarantee at all. They are not an annuity. They are not an insurance product. There are stocks and bonds in there. You are going to be subject to market risks.
Zoll: Our next point, "Once I pick a target-date fund, I can set it and forget it." Is that wise counsel?
Charlson: I would disagree with that one as well. They are products that allow an investor to not really have to pay attention; that's one of their benefits. You are going to get that allocation shifted for you over time in a professional, optimized way. But that doesn't mean you shouldn't be paying attention. There's a lot that can happen. The company might make a change to the glide path. There could be changes to the managers.
So, like any investment, we would recommend you take a look at it at least annually. And then over time, look at that allocation at the end of the glide path: Is this still appropriate for you, your assets, your risk tolerance, from what you thought it was, when you invested in it as a 25-year-old.
Zoll: And finally, target-date funds cost about what any other mutual fund would cost. Is that true, or is that fiction?
Charlson: That's actually fairly true. There is a misconception, perhaps, that they are more expensive, that there is an extra layer of fees. And in the past, maybe 10 years ago, that was more of the case. Most target-date funds have eliminated that layer of fees, and you are really getting something competitive with your typical balanced fund, or other options that you would find in your 401(k) plan. They really are not going to be that much more expensive, if at all.
Zoll: And so, in a sense, you are getting a basket of funds [where] the allocation is being managed for you, and you are not paying anything extra necessarily for that.
Charlson: You are not really paying an additional management fee. In some cases we have seen, you are actually paying less for that basket of funds than you might for some of the underlying funds.
Zoll: Josh, thanks for setting the record straight with us today.
Charlson: All right, thanks.
Zoll: For Morningstar, I'm Adam Zoll. Thanks for watching.