Off Target
NEW RESEARCH suggests that target-date retirement funds���which currently receive a majority of contributions to 401(k) plans���are missing the mark.
Target funds��� returns, in aggregate, lagged those of replica portfolios built with exchange-traded funds (ETFs) by one percentage point a year, according to University of Arizona finance professor David C. Brown, one of the study's authors.
The majority of the underperformance was due to higher fees, Brown said. Target-date funds are funds-of-funds. Most fund families charge investors layers of management fees���both on the target-date fund itself and on the underlying funds.
Active management also cuts into target funds��� returns, according to the study. Active managers, as a group, tend to lag the market averages. The good news: Some target-date funds have some or all of their assets in market-tracking index funds.
Finally, the timing of asset allocation adjustments was a small reason for target funds��� performance lag, accounting for about 1/20th of the return difference, according to the study.
Brown���s study, co-authored with the University of Colorado's Shaun Davies, is titled ���Off Target: On the Underperformance of Target-Date Funds.��� It was presented Nov. 12 at a conference sponsored by the CFP Board Center for Financial Planning.
To assess target funds��� returns, Brown and Davies mixed replica portfolios using 50 low-cost, passively managed ETFs from Vanguard Group. Their performance was compared to equivalent target funds from 2008 to 2020.
���In dollar terms, target-date funds underperformed cumulatively by $35 billion,��� Brown said. The underperformance reached nearly $10 billion in 2019, as target funds��� assets grew to almost $1.6 trillion.
Many workers are automatically invested in target funds when they���re enrolled in their employer's��401(k) plan. Employees can change to other plan investments, but relatively few do. Target funds receive nearly 60% of all plan contributions, according to Cerulli Associates.
The relatively poor performance of most target-date funds may sound disturbing. But before target-date funds took off, many 401(k) plans used a money-market fund as the default investment option���and many participants never changed investments, so they ended up with miserably low investment returns. By contrast, owning a mediocre target-date fund is arguably a big step in the right direction.
What can today���s investor do?
The best scenario: Be lucky enough to have a good fund family supply the target funds in your 401(k), Brown said. Vanguard���s target funds lagged the study���s ETF replica portfolios by just 0.01 percentage point a year. Full disclosure: I worked for Vanguard until I retired last year.
Otherwise, Brown suggested investors could build their own replica target funds by mixing six ETFs���U.S. stock, U.S. bond, international stock, international bond, inflation-indexed bond and real estate.
There are problems with this approach, however. As of 2018, only 21.5% of 401(k) plans offered a brokerage window that would allow participants to buy ETFs, the study noted. It also assumes a level of interest that many 401(k) investors don���t possess.
Alternatively, you could simply invest in a set of low-cost index funds���again, assuming they���re available through your 401(k) plan. Not sure what mix to buy? You could take your cues from a target fund geared to a retirement date similar to when you plan to retire.
Target funds��� returns, in aggregate, lagged those of replica portfolios built with exchange-traded funds (ETFs) by one percentage point a year, according to University of Arizona finance professor David C. Brown, one of the study's authors.
The majority of the underperformance was due to higher fees, Brown said. Target-date funds are funds-of-funds. Most fund families charge investors layers of management fees���both on the target-date fund itself and on the underlying funds.
Active management also cuts into target funds��� returns, according to the study. Active managers, as a group, tend to lag the market averages. The good news: Some target-date funds have some or all of their assets in market-tracking index funds.
Finally, the timing of asset allocation adjustments was a small reason for target funds��� performance lag, accounting for about 1/20th of the return difference, according to the study.
Brown���s study, co-authored with the University of Colorado's Shaun Davies, is titled ���Off Target: On the Underperformance of Target-Date Funds.��� It was presented Nov. 12 at a conference sponsored by the CFP Board Center for Financial Planning.
To assess target funds��� returns, Brown and Davies mixed replica portfolios using 50 low-cost, passively managed ETFs from Vanguard Group. Their performance was compared to equivalent target funds from 2008 to 2020.
���In dollar terms, target-date funds underperformed cumulatively by $35 billion,��� Brown said. The underperformance reached nearly $10 billion in 2019, as target funds��� assets grew to almost $1.6 trillion.
Many workers are automatically invested in target funds when they���re enrolled in their employer's��401(k) plan. Employees can change to other plan investments, but relatively few do. Target funds receive nearly 60% of all plan contributions, according to Cerulli Associates.
The relatively poor performance of most target-date funds may sound disturbing. But before target-date funds took off, many 401(k) plans used a money-market fund as the default investment option���and many participants never changed investments, so they ended up with miserably low investment returns. By contrast, owning a mediocre target-date fund is arguably a big step in the right direction.
What can today���s investor do?
The best scenario: Be lucky enough to have a good fund family supply the target funds in your 401(k), Brown said. Vanguard���s target funds lagged the study���s ETF replica portfolios by just 0.01 percentage point a year. Full disclosure: I worked for Vanguard until I retired last year.
Otherwise, Brown suggested investors could build their own replica target funds by mixing six ETFs���U.S. stock, U.S. bond, international stock, international bond, inflation-indexed bond and real estate.
There are problems with this approach, however. As of 2018, only 21.5% of 401(k) plans offered a brokerage window that would allow participants to buy ETFs, the study noted. It also assumes a level of interest that many 401(k) investors don���t possess.
Alternatively, you could simply invest in a set of low-cost index funds���again, assuming they���re available through your 401(k) plan. Not sure what mix to buy? You could take your cues from a target fund geared to a retirement date similar to when you plan to retire.
The post Off Target appeared first on HumbleDollar.
No comments have been added yet.
