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Why You Might Want To Avoid Target Date Funds

Popular retirement savings vehicles are no match for index fund ETFs Paul Price argues.

Target date funds are a retirement product that have drawn plenty of investors over the year. They offer to grow in value toward a specific financial goal by a specific date. The idea is that you pick one built around the year you plan on retiring, and the fund is managed to balance risk and reward around that specific time frame.

They also, writes Real Money's Paul Price, don’t seem to work very well. 

“Target-date mutual funds and exchange traded funds were devised to automate asset allocation for people with years to go until retirement," Price wrote recently on Real Money. "They adjust the mixture of stocks, bonds and cash to reduce equity exposure, and its accompanying volatility, as investors' expected retirement dates approached.

While that followed classical financial planning advice, did it really accomplish most peoples' ultimate goal of maximizing their wealth over time? After all, the more money you have at retirement age, the better your life style can be.

So Price did some math. "To check out how target-date funds actually performed, I've documented Fidelity's 2025, 2030, 2035, 240 and 2050 target-date funds over the 10 and 15-year periods ended Sep. 28, 2021… All these Fidelity funds were listed as four stars out of five. They were not poor performing laggards.”

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From a pure safety perspective, Price found, target date funds do well. The ones he studied outperformed conservative positions like bank CDs and Treasury bonds. Most investors don’t just stick with the zero-risk position though. Once Price started comparing target date funds against how investors actually behave, the wheels started coming off the wagon.

To see how these funds compare with the stock market, he writes, “you need to compare how they did versus a simple index fund or ETF which was designed to match the S&P 500. Those alternatives are readily available and carry much lower expense ratios than the funds shown.”

“If you liked the Fidelity Target-Date fund returns, you would have loved the S&P 500 even more. Simply mimicking the index far outperformed every one of the asset allocation models over the most recent decade."

That held true over the longer period as well. "Even during the 15-year period, when lots of bad things happened to equities, the S&P 500 still beat every single one of the target-date funds. Bad times for stocks are when holding bonds and cash are expected to preserve your wealth. Instead, every single one of those target-date funds lagged what was to come simply riding out the volatility."

Target date funds make big promises, but Price found they underperformed a simple S&P 500 investment every time.