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The case against target retirement funds

Updated on August 10, 2015

Target retirement funds are available in many 401K plans.

Most of the 401K plans I have reviewed have target retirement funds. These funds are easy to identify because they usually have a date in their fund name. Two examples are the Fidelity Freedom 2030 fund or the Vanguard target retirement 2030 fund.

I want to start out saying some good things about these funds. Sometimes in a 401K or 403B these funds are the best option for the investor only due to the limited number of investments offered in a 401K or 403B. These funds practice a pretty good asset allocation. Most of these funds are broadly diversified and many invest in more than 10 mutual funds. If an investor is unwilling to take steps to monitor and modify their investments target retirement funds are reasonable options.

Target retirement funds perform an asset allocation on one criterion a person’s age or as the fund may state the date they wish to retire. To use an analogy that would be like saying everyone age 45 should be in the same investments. People have differing tolerance for risk. Some people cannot stand when their 401K loses a dime. Others see it as an opportunity to buy more shares at a lower price. Clearly these two people who may be the same age should not have the same asset allocation.

Better investing means more money.

Most investors can do better than target retirement funds
Most investors can do better than target retirement funds

Most investors can do better than target retirement funds

I compared the performance of four target retirement funds for the date 2030 and found little difference between all four funds and the S&P 500 index. Good but not spectacular performance.

Looking at the funds the T Rowe Price Target 2030 Fund is a five star fund as rated by Morningstar. Looking into its top ten holdings one sees several mutual funds all of which are T Rowe Price funds. That means that all of the research is done by T Rowe Price. That means less diversity in your portfolio than you would at first believe. The top holding is the T. Rowe Price Value Fund. This is a very middle of the road fund. It is rated 3 stars. All of the top ten holdings are three and four star funds.

Another fund the Fidelity Freedom 2030 fund is a three star fund as rated by Morningstar. This funds performance does not vary significantly from the T Rowe Price Target 2030 Fund listed above. Like the Price fund all of the top ten funds are Fidelity funds. Two of the funds are relatively new and unrated others range from 2 star to 4 star. Many of the funds in the Fidelity Freedom 2030 are very large bloated fund which I would recommend selling if owned in an account. Still the performance of the Fidelity Freedom 2030 fund is not significantly different from the T Rowe Price Target 2030 Fund.

Out of all of the 2030 funds I investigated I found the stock portion of the portfolio to be from 71 percent to 85 percent. All of the funds with the exception of the Wells Fargo Advantage DJ Target 2030 fund were composed totally of funds from the parent fund company. The Wells Fargo Advantage DJ Target 2030 is a little different type of fund as this fund owns single stocks.

As far as asset allocation goes the target retirement funds are pretty good. Target retirement funds are a bastion of mediocrity. One could make much worse investment decisions but a wise investor could do much better. I would like to see you do better with your hard earned money.

By selecting the best mutual funds an investor can far outperform a target retirement fund. Select the best small cap,best mid cap, large cap,concentrated portfolio, international and bond funds and you will have a better tomorrow.

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