The best target-date fund (TDF) can be a hard choice. You have 10 to 60 years of savings in front of you, so you absolutely need to pick the right target-date fund. You only get one shot at retirement, so choosing the right fund means retiring in style instead of looking over your shoulder for bill collectors!
It is updated with 2019 returns.
Why you need a target-date fund
Target date funds offer an easy way to manage your money. Investment companies often provide them as 1-fund-solution. The date mentioned in the fund is the date (year) in the future where you are planning to retire. Let us take the example of Vanguard. Their 2050 target date fund is called: Vanguard Target Retirement 2050 Fund. This means that if you are planning to retire at 65 years old in the year 2050, you should buy this fund.
All target-date funds have one characteristic feature. They all make use of a glide path to guide the asset allocation within the fund. All target-date funds make use of two main components to build their assets allocation and the glide path. The two parts are risky assets and safe assets. These two components can be broken down into individual asset classes.
The risky assets include the following asset classes:
- Equities (stocks) (large-cap, small-cap, value, growth, etc.)
- High yield bonds
- Private equity
- Emerging market bonds
The safe assets include the following asset classes:
- Government bonds (from developed economies)
- High-grade bonds (investment-grade corporate bonds)
- Cash (money market accounts)
- Municipal bonds
The glide path determines the ratio of risky assets to safe assets in the fund. The longer you have until retirement, the more risky assets should be in your portfolio. For example, if you plan on retiring in 2060, you will have many risky assets in your portfolio (at least 90 % will be in risky assets). They offer the best returns over long periods but are more volatile. On the other hand, if you plan on retirement in 2030, you will have less risky assets and more in safe assets (maybe closer to 50% in each).
Now here is the smart thing about target-date funds: They all balance their ratio of a risky and safe asset for each year you grow closer to retirement. You don’t have to do a thing, it all happens automatically. This is the glide path feature.
Now that you know what a target date fund is let us have a look at the contenders for the best target-date fund.
These are the best target-date fund, contenders
Below are the contending portfolios. The list includes both individual funds from fund companies and portfolios using a glide path approach. The difference is that at a mutual fund company, you can buy one fund and be done (the 1-fund-solution). In the DIY portfolios, you need to maintain the portfolio yourself and rebalance every year. This is not any different or any more difficult than a standard rebalancing. We have a post and a spreadsheet describing it.
- Vanguard Target Date Funds (1 fund solution)
- Paul Merriman’s Target Date Portfolios (DIY portfolio)
- Fidelity Freedom Index Funds (1 fund solution)
- Schwab Target Date Funds (1 fund solution)
- Morningstar Lifetime Indices (DIY portfolio)
- Dimensional 2030 Target Date Retirement Income Fund (1 fund solution)
- TIAA-CREF Lifecycle Funds (1 fund solution)
The basis for our measurement is the portfolios that are tracked by portfolioeinstein.com. As per 13/09/2018, we are tracking 235 portfolios. All the portfolios are buy-and-hold and assume a lump sum investing in 1989 along with yearly rebalances.
The years tracked are from 1989 to 2018.
We are only looking at the compound annual growth rate of the investments (CAGR). This is the standard way of measuring returns of investments on portfolios. CAGR takes interest-on-interest into account.
For example, $1 earning 10 percent interest this year would be worth $1.10 by the end of the year. ($1 times 1.1) Next year the $1.10 grows to $1.21. ($1.1 times 1.1). In ten years that $1 becomes $2.5. This is the compounding effect in action.
All the portfolios are using the same data. Here are the sources for the data.
The individual target-date funds all list their asset allocations on their web pages. These are benchmarked against our historical asset class database.
The funds all start in 1989 with an initial $10,000 investment.
The best target-date fund
We are listing 4 target dates and compare the portfolios. The 4 target dates are:
- 2060 (25 years old)
- 2050 (35 years old)
- 2040 (45 years old)
- 2030 (55 years old)
Here are the results grouped by target date:
2060 Target Date Retirement Portfolios
2050 Target Date Retirement Portfolios
2040 Target Date Retirement Portfolios
2030 Target Date Retirement Portfolios
Measuring the performance of target-date funds is shooting at a moving target. When benchmarking a target-date fund, you must remember that you will not get the returns for the entire period. Instead, the glide path feature of the fund ensures that the fund is decreasing the risk of the fund over time. That is the whole point of the target date fund! The number of risky assets will reduce over time, lowering your return but decreasing your risk as well. Most target-date funds rebalance their allocations each year (some each month).
So what stands out from the above comparison? Three things surprised me when comparing the target date funds:
- The Paul Merriman target-date portfolios blew everyone else out of the water. Paul Merriman’s target-date retirement portfolios are heavily weighted towards small-cap and small-cap value. Historically two of the best performing asset classes.
- I was surprised that the Vanguard funds came in last. However, I am equally surprised that the Morningstar Lifetime Allocation Index did so well. The difference between the two comes down to slicing and dicing the portfolio. Vanguard takes a simple approach to portfolio construction. Vanguard typically only have four funds in their target-date funds:
- US Total Stock Market (VTI)
- International All-World ex-US (VEU)
- Total US Bond Market (BND)
- Non-US Bonds (BNDX)
Compare that to Morningstar Lifetime Allocation Indices:
- US Large Cap Value (VTV)
- US Large Cap (VV)
- US Large Cap Growth (VUG)
- US Mid Cap Value (JKI)
- US Mid Cap (IJH)
- US Mid Cap Growth (IJK)
- US Small Cap Value (VIOV)
- US Small Cap (VIOO)
- US Small Cap Growth (IJT)
- REITs (VNQ)
- International Developed Blend (VEA)
- Emerging Markets (VWO)
- Total US Bond Market (BND)
- Commodities (DBC / GSG)
They are both massively diversified, but the Morningstar Lifetime Allocation Indices can make better use of rebalancing because of its slicing and dicing.
- There is a VERY LARGE difference among the target date funds, which are magnified by the compounding effect. Here is the difference in dollar amounts between the best performing and worst performing in each bracket:
- 2030 Target Date Retirement Portfolios – $95,637 vs. $130,666 or a 37% difference
- 2040 Target Date Retirement Portfolios – $101,611 vs. $194,370 or a 93% difference
- 2050 Target Date Retirement Portfolios – $102,950 $230,855 or a 124% difference
- 2060 Target Date Retirement Portfolios – $102,758 vs. $245,490 or a 139% difference
The reason for the difference is partly the amount of slicing and dicing of the portfolios but mostly due to the number of bonds in proportion to stocks the target date fund is holding. Very often, the target date funds are too conservative and not aggressive enough, which hurts their performance. Quite simply, they hold too many bonds for too long. A good rule of thumb is for each 10% bonds in proportion to stocks. You are giving up a 0.5% return each year.
Do you need a target date fund?
That depends. Do you want it easy, or do you want to pick up a few extra thousands of dollars when you retire?
In my opinion, managing your portfolio by following one of the portfolios on portfolioeinstein.com is very easy, and you will come out ahead of the target date fund. It only requires a few hours of work every year, as well as setting up the initial portfolio. That’s a fantastic hourly wage!
A target-date fund is a great starting point and, for some, a great endpoint. It automates your investing and makes it easy. If you want to pick up a couple more percentage points, you could tilt towards historically better-performing asset classes like value stocks, small-caps, and small-cap value.
Summary and next steps
A target-date fund is an easy solution when investing for retirement. There are significant differences in the performance of the portfolios of the funds, so make sure you carefully research the fund you want to invest in. The best target-date fund is Paul Merriman’s portfolios that rely on small-caps and small-cap value.
If you have come across a target date fund that you want a second opinion on, let me know in the comments!
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