As with anything investment-related, see my disclaimers. Investing involves risk. My analysis is provided solely for entertainment purposes and in no way do I recommend any course of action. Don't trust random idiots like me on the internet for investing advice. Or for anything else, for that matter.
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In a previous post I looked at target date funds offered by Vanguard. In my opinion, they are a great benchmark to measure other target date funds, including the target date funds offered in my current 401(k). So let’s see how my current 401(k)’s target date fund options measure up.
The first comparison is the equity/income allocation. As with the Vanguard target date funds, the funds in my 401(k) have a “glide” path. The closer the fund is to the expected retirement date and beyond, the more the allocation shifts away from equities and international towards bonds and TIPS.
Here’s what the glide path looks like:
You can see it’s very similar to the glide path for Vanguard’s target date funds:
Comparing the curves, the funds in my 401(k) appear to be a little more conservative the closer one gets to retirement.
Access To Additional Markets
Another thing to look at is the underlying investments that make up the target date funds. The Vanguard funds had on average four underlying funds. Looking at my 401(k) target date funds, I see a total of twelve different underlying investments, with each individual target date fund invested in anywhere from nine to ten of those twelve funds.
Why so many? Digging in, I see that my 401(k)’s target funds include exposure to additional things like international small cap, emerging markets, and real estate. They also break the US equity group into small- and mid-cap options. None of that exposure is available in the Vanguard options nor as standalone investment options in my 401(k).
Here’s a new glide path graph that shows this additional exposure:
Another point to compare is on investment fees. The Vanguard target date funds all varied between .12% and .15%. So how about my 401(k)’s target date options? Across the board, every target date fund in my 401(k) plan has an investment fee of .29%. Ouch!
Now I’ll concede the point that exposure to those “exotic” emerging markets or real estate options comes with higher cost than the S&P 500 option. But how much of that .29% fee is justified?
Let’s take the 2065 option as an example. This fund is geared towards those returning around 2065 and are in the 20 to 25 year-old range today. 90% of the fund’s allocation is composed of funds that are available for direct investment as 401(k) options. Because they’re available for direct investment, we can look up their investment fees. And summing up their weighted portion, we can account for .09%. 10% of the allocation is responsible for 70% of the fee, or .20%. That’s equivalent to paying a 2% investment fee for that extra diversity! No thanks!
Assigning the leftover investment fee all on the shoulders of the exotic investments is probably not 100% fair. Even Vanguard’s target date funds come with a higher investment fee than the underlying funds that make up the target date fund. A DIY target date fund using Vanguard funds with a matching allocation would save you about half of the target date fee, so we should probably also bake in some part of the fee to the providers overhead. But it still seems like the extra exposure isn’t worth it versus building my own target date fund using the available options in my 401(k).
Assume a participant starts investing at age 25 and maxes out their 401(k) contribution each year, and earns an inflation-adjusted return of 3%. Compared to a DIY target date fund built from Vanguard index funds, those fees could cost upwards of $90k or more, in today’s dollars, by the time they retire. Here’s what that comparison looks like:
I get the convenience of target date funds. However, please don’t forget that they come with a cost. With only a little bit of effort, you can usually replicate the target date fund and end up with lower costs. And maybe even customize for your own financial situation.
If you’re looking for simplicity and willing to pay more for that simplicity, the target date fund isn’t going to kill your retirement.
Do you use the target date funds in your retirement plan? I’d love to hear about it.