3 Target-Date Funds for an IRA in 2022

Susan Dziubinski:

Hi, I'm Susan Dziubinski with Morningstar. Investors have until April 18 to make an IRA contribution if they want that contribution to count for tax-year 2021. Should you consider a target-date fund for your IRA? Perhaps you should. Joining me today to talk about how target-date funds can work within IRAs and to share a few of her favorite target-date series is Megan Pacholok. Megan is an analyst with Morningstar's Multi-Asset Manager Research team.

Hi, Megan. Good to see you.

Megan Pacholok:

Hi, Susan. Good to be here.

Dziubinski:

Let's start out with a little bit of a definition of what a target-date fund is and how it works.

Pacholok:

Right. So, a target-date fund is designed to be a hands-off investment solution for investors to save for retirement, and typically, they start out with mostly equities within their portfolio, and as you get closer and closer to your target retirement date, they will become a little bit more conservative by adding bonds into the portfolio.

Dziubinski:

Then, why are target-date funds something that people should be thinking about perhaps for an IRA? Why are they good choices for that tax-deferred wrapper?

Pacholok:

For both a Roth and a traditional IRA, they provide a tax advantage for investors that are saving for retirement, while that target-date fund allows those investors to have a more hands-off solution that they don't really have to build, monitor, or rebalance because the portfolio manager is really taking care of those steps.

Dziubinski:

Then, who might a target-date fund be a better fit for? What type of investor?

Pacholok:

Typically, for an investor that doesn't have that much time to spend looking at their portfolio because they're kind of offloading it to their portfolio manager.

Dziubinski:

Now, Morningstar rates target-date series and target-date funds, and you're very involved in that process. So, if an investor is looking at a couple of different target-date funds and considering them for an IRA, what are the types of things he or she should be looking at?

Pacholok:

When you're making any sort of investment decision, the cost should definitely be a big factor that you're looking at, and target-date funds are no exception. For the most part, they are reasonably priced, especially if you're thinking that they're your entire portfolio. And typically, the price is driven by the underlying funds that are included within the series. So, if you have a series that has all index funds, they tend to be on the cheaper end of the spectrum. Whereas on the other side, if you have one that invests in all active funds, they tend to be a little bit more expensive. We have found that those plans that have a healthy balance of both tend to find the middle road, too.

The other important consideration when you're looking at a target-date fund is how much risk they're taking at that target retirement date because essentially, there, the investor's retirement savings will have hit a peak, because from that point they won't really be making any more contributions--instead, they'll be switching to withdrawals. And their investment time horizon is a bit shorter, so they don't have as much time to make up for any market drawdowns. And so, finding a nice target-date fund that has an appropriate risk level is another strong consideration, because although most of them have about an average of 40% in equities, it can really range from below 20% to up to 55%.

Dziubinski:

Now, let's talk a little bit specifically about a few target-date series that Morningstar thinks highly of. The first one that we're going to talk about has been a little bit in the news lately, and it's from Vanguard. It recently made a pretty large capital gains distribution, and that took some investors who held the target-date series in taxable accounts a little bit off-guard. So, talk a little bit about what happened there.

Pacholok:

In December of 2020, Vanguard actually reduced the minimum investment level needed for their institutional share class to $5 million from $100 million. That large reduction made a lot more investors eligible for the cheaper share class. Unfortunately, in 2015, when Vanguard launched the institutional share, they launched it as a separate mutual fund rather than a new share class. So, when plans were selling out of the investor share class and buying into the institutional share class, it triggered a surprisingly larger capital gains distribution. But again, that only affected those in a taxable account. If you held your target date in an IRA, you wouldn't have been subject to that tax.

Dziubinski:

Again, it seems like this experience with this large distribution only adds to the argument in favor of keeping target-date funds and target-date strategies in some sort of tax-deferred account, like an IRA or a 401(k), right?

Pacholok:

That's right, Susan.

Dziubinski:

Megan, let's talk some specifics about this Vanguard target-date series. It's an all-index fund series. Tell us what you like about it.

Pacholok:

The Vanguard Target Retirement Series is a low-cost option. It's actually one of the lowest-priced target-date funds in the industry, and it invests in global broad market indexes. So, it's really covering all of its bases there. And it's really simple and easy for an investor to understand. So, the simplicity of it, coupled with its low cost, makes it a great option for an average investor.

Dziubinski:

And your second idea today invests in strictly actively managed strategies, and that's T. Rowe Price Retirement.

Pacholok:

That's right. So, T. Rowe Price Retirement is an all-active series, and it's managed by one of the top teams in asset-allocation research and execution. And at the onset of the glide path, it is a little bit more aggressive. It has about 98% in equities at that point. But we have a lot of confidence in the underlying stock-pickers and the equity funds that they're using. In terms of their bond portfolio, it is a little bit more adventurous. But historically, the bond funds have bounced back from market drawdowns. So, we think if an investor is able to stick with that volatility, it should lead to long-term success.

Dziubinski:

And then, your last idea today sort of blends active strategies with passive strategies, and it's Pimco RealPath Blend. Tell us about it.

Pacholok:

That's right. So, Pimco RealPath Blend does a great job of showing that it doesn't have to be all or nothing, and it balances index funds as well as active funds. So, their equity exposure is all through Vanguard equity index funds, while their bond portfolio is through their in-house active bond funds. And we really think that that's a smart match in setting up investors for success.

Dziubinski:

Megan, thank you so much for your time today. You've given us some food for thought when it comes to target-date funds in an IRA and a few good series to check out. We appreciate it.

Pacholok:

Thanks for having me, Susan.

Dziubinski:

I'm Susan Dziubinski with Morningstar. Thank you for tuning in.