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5 Reasons To Think Twice About Your Target-Date Fund
"The average charge for a target-date fund is 0.73% ... The average stock fund charges 0.68%, while the average bond fund charges 0.54%."
I'm surprised the averages are that low. Perhaps if index funds and ETFs are included that's true. But for actively managed funds those .68% and .54% averages look low to me. A good actively managed international stock fund often exceeds 1% in expenses.
The debate over target date funds (which vary widely) has been going on now for at least a decade. My thinking is that people who don't read MFO or otherwise take much interest in investing are probably well served by them. Think of them as a default option. For the more financially inclined/literate there's better approaches.
The only retirement fund I own is TRRIX, a conservative 40/60 fund with a .56% ER. Price keeps cost down in part by investing 20% in their S&P index fund. You also get 14-15% exposure to some of their international equity funds. Contrary to industry practice, you'll find Price's asset allocation and target date funds generally a bit cheaper to own than if you bought the underlying funds yourself.
The reason I prefer TRRIX to their other retirement funds is that this one doesn't follow any glide slope. (A bit of a control freak).
Target-date funds are a great financial innovation with the potential to help millions of investors. But if you do set your investments that way, you shouldn’t ever really forget them.
Investors on autopilot may never learn the basic financial concepts for themselves, just as self-driving cars may lull us into a dangerous complacency.
If something goes wrong — and in 2008, not only did funds fall in value more than some investors expected but some were found to be impermissibly overweighting their equity holdings, in violation of their prospectus — we may suffer more damage than if we had never relied upon them. That sounds something like when a car’s autopilot fails and passengers are hurt in accidents they might easily have avoided with a little attention to the road.
Everyone needs to make the decision themselves whether these investment vehicles are appropriate for them. As convenient as they are, we rebalance our portfolio several times annually and autopilot is not for us.
"The average charge for a target-date fund is 0.73% ... The average stock fund charges 0.68%, while the average bond fund charges 0.54%."
I'm surprised the averages are that low. Perhaps if index funds and ETFs are included that's true.
What likely sounds more familiar to you are figures around 1.25%. That's what one gets by equal-weighting funds - giving as much weight to AMDEX (ER 3.38%, an index fund tracking the Israeli market) as to VFINX.
Here's a M* paper from 2014 giving weighted and unweighted (i.e. equal-weighted) averages of funds from 1990 through 2013 - overall averages and averages by fund type. The 2013 figures are very close to the current ones (e.g. 0.67% for weighted average of all US equity mutual funds). You're right that these figures include index funds, but they exclude ETFs, as those are not open end funds.
Contrary to industry practice, you'll find Price's asset allocation and target date funds generally a bit cheaper to own than if you bought the underlying funds yourself.
Theoretically, a fund can't be cheaper than buying the underlying funds. The TRP fund "will indirectly bear its pro-rata share of the expenses of the underlying T. Rowe Price funds in which it invests (acquired funds)." (from prospectus).
Most families may add fees on top of what it costs to own the underlying funds. But there's more going on here. Look at Fidelity - it tacks on a modest fee (about 8 basis points) to its Freedom Index target date funds. The underlying funds are cheap index funds with little profit margin to pay for the extra overhead of running target date funds. In contrast, Fidelity Freedom funds (that invest in actively managed funds) don't tack on an additional fee.
T. Rowe Price may be using index funds as some of the underlying funds, but they're known to be not particularly cheap. So TRP doesn't need to tack on additional fees.
Vanguard takes a different approach. Its target date funds invest in higher cost Investor class shares, rather than Admiral shares. That difference allows it to absorb the target funds' administrative costs without losing money.
The reason I prefer TRRIX to their other retirement funds is that this one doesn't follow any glide slope. (A bit of a control freak).
What it sounds like you want is an asset allocation fund, as opposed to a target date/retirement fund. TRP appears to call TRRIX a retirement fund (as opposed to a Personal Strategy, i.e. asset allocation fund), only because it is a fund of funds; not because it is a real retirement fund.
There are only a few parameters that differentiate various groups of hybrid funds: 1) Glide path yes/no (target date/asset allocation) 2) Fund of funds yes/no (minimal extra overhead for fund of funds, sometimes absorbed) 3) How aggressive (for target date funds, the glide path; for asset allocation the "neutral" mix) 4) Indexed (primarily for funds of funds - are the underlying funds index funds)
BTW, I applaud TRP for offering two different classes of funds with different glide paths, so that one can choose the level of aggressiveness.
I really don't give Tgt-funds a thought until I see a thread about them.
Besides the cost, don't like their allocations based on the age of the investor, rather than the cheapness/dearness of the sundry assets they invest in. -- The capital-markets don't know or care how far away from retirement we are. Consequently, its my bull-headed belief that we investors should very much care how richly/cheaply priced the assets we are buying/holding are.
Observation (not related to any posters here, but just generally): So many investors are proudly 'cost-conscious', but then intentionally invest in a manner which is not 'price-conscious'. Tgt-funds seem to assiduously cling to that latter behavior.
Lastly, I find it telling that the companies offering tgt-funds populate them with their OWN proprietary funds. No fund company, not Vanguard, Fidelity, TRowe, etc., own a monopoly of above average funds. Given that, if the tgt-fund provider had their investors' best interest front-and-center, they should arrange to populate tgt-funds with the best available funds, even if some are NOT in-house. That they don't do so, suggests to me, underlying basis for marketing tgt-funds is not to better serve investors, but to amass and keep-in-place as many AUM across their fund complex (yes, a shock, I know!!). -- And to do so by catering to many retail investors who prefer to not have to think too hard about investing.
@msf - You and I can't buy their institutional shares of some of the underlying funds - which do carry lower costs (unless you've got whole lot more money than I think). I'll rest my case there.
However, I read somewhere (over a decade ago) that Price does actually give back a small portion of the underlying ERs to their allocation funds - on the theory that they save money in the long run by not having as many separate accounts to manage. Put another way, they'd rather have you put all your money into RPSIX than have you own smaller amounts of 12 different income funds. It made sense to me at the time, but unfortunately, I've never been able to verify it. (And I've searched their Prospectus's trying to verify)
You are completely correct on the second point. While TRRIX is classified a retirement fund by Price, alongside their target date funds, it is actually an asset allocation fund. I guess you could say that I avoid the target date variety of retirement funds (as most everyone here is probably inclined to do).
Edmond: No intent on my part to in any way promote Price, its funds, actively managed funds, any particular investing style, or allocation and target date funds. To each his own. What caught my eye was the lower than expected "average" fund expenses stated in Ted's linked article. In trying to make sense of those numbers I strayed too far afield. But you make some excellent points.
@hank - I'm always happy to admit I've overlooked something. (Well, not exactly happy, but willing) So I went back and checked the holdings (1Q2016) of TRRIX.
None of the funds it holds are marked as institutional. In contrast, the holdings of TRPTX are all listed as <fund name>-I, indicating institutional class.
As you mentioned, TRP's institutional class funds are open to retail investors; for TRPTX all you need is a million bucks. Though they are more welcoming if you buy the shares through a retirement plan at work.
Savings to the underlying funds are expected to result primarily from the elimination of numerous separate shareholder accounts which are or would have been invested directly in the underlying funds and the resulting reduction in shareholder servicing costs. Although such cost savings are not certain, the estimated savings to the underlying funds generated by the operation of the Retirement Funds are expected to be sufficient to offset most, if not all, of the expenses incurred by the Retirement Funds.
In other words, the savings in the underlying funds (best case) would bring the ER of the Retirement Funds down to zero (not below). The fee table in the prospectus shows each fund as having fees that are exactly offset by the savings, so that the net ER is exactly equal to the cost of owning the underlying funds. Not cheaper - these savings just explain how TRP offers funds of funds with no additional costs.
@Edmond: " Consequently, its my bull-headed belief that we investors should very much care how richly/cheaply priced the assets we are buying/holding are. ... So many investors are proudly 'cost-conscious', but then intentionally invest in a manner which is not 'price-conscious'. Tgt-funds seem to assiduously cling to that latter behavior. "
Perhaps this is just a matter of watch what I do, not what I say, but FWIW, what TRP says:
The allocations shown in the glide path are referred to as "neutral" allocations because they do not reflect any tactical decisions made by T. Rowe Price to overweight or underweight a particular asset class or sector based on its market outlook. The target allocations assigned to the broad asset classes (Stocks and Bonds), which reflect these tactical decisions resulting from market outlook, are not expected to vary from the neutral allocations set forth in the glide path by more than plus (+) or minus (-) five percentage (5%) points.
Generally speaking, this flexibility is the differentiating attribute between asset allocation funds and static balanced funds (whatever their selected balance is).
Re: "Savings to the underlying funds are expected to result primarily from the elimination of numerous separate shareholder accounts which are or would have been invested directly in the underlying funds and the resulting reduction in shareholder servicing costs. Although such cost savings are not certain, the estimated savings to the underlying funds generated by the operation of the Retirement Funds are expected to be sufficient to offset most, if not all, of the expenses incurred by the Retirement Funds."
MSF: Wow. Nice find! Apparently that's what I remember seeing. Not what I had long assumed. Still helps explain why their allocation funds are a better deal for investors than many others which do level allocation or administration fees.
As for TRRIX not being invested in anyinstitutional class shares, don't be too sure. It does have a 20.3% weighting in PRCIX, Price's New Income Fund. PRCIX in turn holds institutional class shares in two other T. Rowe Price funds: Floating Rate and High Yield. In addition, both TRRIX and PRICX have the ability to invest in Summit Cash Reserves (not institutional - but having a $25,000 minimum) although they appear to have only trace exposure to that fund at present.
Thanks for your input. Interesting. -
PS: Re TRPTX - I like that one better. .47% ER and invested in institutional shares. But can't quite afford the $1 mil minimum.
Comments
I'm surprised the averages are that low. Perhaps if index funds and ETFs are included that's true. But for actively managed funds those .68% and .54% averages look low to me. A good actively managed international stock fund often exceeds 1% in expenses.
The debate over target date funds (which vary widely) has been going on now for at least a decade. My thinking is that people who don't read MFO or otherwise take much interest in investing are probably well served by them. Think of them as a default option. For the more financially inclined/literate there's better approaches.
The only retirement fund I own is TRRIX, a conservative 40/60 fund with a .56% ER. Price keeps cost down in part by investing 20% in their S&P index fund. You also get 14-15% exposure to some of their international equity funds. Contrary to industry practice, you'll find Price's asset allocation and target date funds generally a bit cheaper to own than if you bought the underlying funds yourself.
The reason I prefer TRRIX to their other retirement funds is that this one doesn't follow any glide slope. (A bit of a control freak).
Here's a M* paper from 2014 giving weighted and unweighted (i.e. equal-weighted) averages of funds from 1990 through 2013 - overall averages and averages by fund type. The 2013 figures are very close to the current ones (e.g. 0.67% for weighted average of all US equity mutual funds). You're right that these figures include index funds, but they exclude ETFs, as those are not open end funds. Theoretically, a fund can't be cheaper than buying the underlying funds. The TRP fund "will indirectly bear its pro-rata share of the expenses of the underlying T. Rowe Price funds in which it invests (acquired funds)." (from prospectus).
Most families may add fees on top of what it costs to own the underlying funds. But there's more going on here. Look at Fidelity - it tacks on a modest fee (about 8 basis points) to its Freedom Index target date funds. The underlying funds are cheap index funds with little profit margin to pay for the extra overhead of running target date funds. In contrast, Fidelity Freedom funds (that invest in actively managed funds) don't tack on an additional fee.
T. Rowe Price may be using index funds as some of the underlying funds, but they're known to be not particularly cheap. So TRP doesn't need to tack on additional fees.
Vanguard takes a different approach. Its target date funds invest in higher cost Investor class shares, rather than Admiral shares. That difference allows it to absorb the target funds' administrative costs without losing money. What it sounds like you want is an asset allocation fund, as opposed to a target date/retirement fund. TRP appears to call TRRIX a retirement fund (as opposed to a Personal Strategy, i.e. asset allocation fund), only because it is a fund of funds; not because it is a real retirement fund.
There are only a few parameters that differentiate various groups of hybrid funds:
1) Glide path yes/no (target date/asset allocation)
2) Fund of funds yes/no (minimal extra overhead for fund of funds, sometimes absorbed)
3) How aggressive (for target date funds, the glide path; for asset allocation the "neutral" mix)
4) Indexed (primarily for funds of funds - are the underlying funds index funds)
BTW, I applaud TRP for offering two different classes of funds with different glide paths, so that one can choose the level of aggressiveness.
Besides the cost, don't like their allocations based on the age of the investor, rather than the cheapness/dearness of the sundry assets they invest in. -- The capital-markets don't know or care how far away from retirement we are. Consequently, its my bull-headed belief that we investors should very much care how richly/cheaply priced the assets we are buying/holding are.
Observation (not related to any posters here, but just generally): So many investors are proudly 'cost-conscious', but then intentionally invest in a manner which is not 'price-conscious'. Tgt-funds seem to assiduously cling to that latter behavior.
Lastly, I find it telling that the companies offering tgt-funds populate them with their OWN proprietary funds. No fund company, not Vanguard, Fidelity, TRowe, etc., own a monopoly of above average funds. Given that, if the tgt-fund provider had their investors' best interest front-and-center, they should arrange to populate tgt-funds with the best available funds, even if some are NOT in-house. That they don't do so, suggests to me, underlying basis for marketing tgt-funds is not to better serve investors, but to amass and keep-in-place as many AUM across their fund complex (yes, a shock, I know!!). -- And to do so by catering to many retail investors who prefer to not have to think too hard about investing.
So... still not interested in them.
However, I read somewhere (over a decade ago) that Price does actually give back a small portion of the underlying ERs to their allocation funds - on the theory that they save money in the long run by not having as many separate accounts to manage. Put another way, they'd rather have you put all your money into RPSIX than have you own smaller amounts of 12 different income funds. It made sense to me at the time, but unfortunately, I've never been able to verify it. (And I've searched their Prospectus's trying to verify)
You are completely correct on the second point. While TRRIX is classified a retirement fund by Price, alongside their target date funds, it is actually an asset allocation fund. I guess you could say that I avoid the target date variety of retirement funds (as most everyone here is probably inclined to do).
Edmond: No intent on my part to in any way promote Price, its funds, actively managed funds, any particular investing style, or allocation and target date funds. To each his own. What caught my eye was the lower than expected "average" fund expenses stated in Ted's linked article. In trying to make sense of those numbers I strayed too far afield. But you make some excellent points.
None of the funds it holds are marked as institutional. In contrast, the holdings of TRPTX are all listed as
<fund name>-I, indicating institutional class.
As you mentioned, TRP's institutional class funds are open to retail investors; for TRPTX all you need is a million bucks. Though they are more welcoming if you buy the shares through a retirement plan at work.
TRRIX holdings: http://individual.troweprice.com/staticFiles/gcFiles/pdf/phrpeq1.pdf
TRPTX holdings: http://individual.troweprice.com/staticFiles/gcFiles/pdf/phrqiq1.pdf
@Edmond: " Consequently, its my bull-headed belief that we investors should very much care how richly/cheaply priced the assets we are buying/holding are. ... So many investors are proudly 'cost-conscious', but then intentionally invest in a manner which is not 'price-conscious'. Tgt-funds seem to assiduously cling to that latter behavior. "
Perhaps this is just a matter of watch what I do, not what I say, but FWIW, what TRP says: Generally speaking, this flexibility is the differentiating attribute between asset allocation funds and static balanced funds (whatever their selected balance is).
MSF: Wow. Nice find! Apparently that's what I remember seeing. Not what I had long assumed. Still helps explain why their allocation funds are a better deal for investors than many others which do level allocation or administration fees.
As for TRRIX not being invested in any institutional class shares, don't be too sure. It does have a 20.3% weighting in PRCIX, Price's New Income Fund. PRCIX in turn holds institutional class shares in two other T. Rowe Price funds: Floating Rate and High Yield. In addition, both TRRIX and PRICX have the ability to invest in Summit Cash Reserves (not institutional - but having a $25,000 minimum) although they appear to have only trace exposure to that fund at present.
Thanks for your input. Interesting.
-
PS: Re TRPTX - I like that one better. .47% ER and invested in institutional shares. But can't quite afford the $1 mil minimum.