target date mutual funds webinar slides-05-15
TRANSCRIPT
The Ins and Outs of Target Date Funds and the New L Funds TSP
Default Option- Part 1 https://learn.extension.org/events/2030#.VQwbhk0tGM8
Barbara O’Neill, Ph.D., CFP® Rutgers Cooperative Extension
Workshop Objectives- Part 1
Learn background, history, and characteristics of target date funds
• Learn advantages and disadvantages of target date funds
• Learn the difference between target date (lifecycle) funds and lifestyle funds
• Learn how glide paths work
• Learn about target date fund resources
Question #1: Do you invest in target date mutual funds? If so, which one(s)?
Take-Away #1: TDFs become more conservative automatically
What is a Target Date Fund (a.k.a., Lifecycle Fund)?
• Diversified mutual fund portfolio consisting of 3 asset classes: stocks, bonds, cash equivalents
• Asset allocation automatically adjusts; becomes more conservative (less stock) over time
• Typically “fund of funds” with underlying funds from the same fund family
– Vanguard Target Retirement Funds
– Fidelity Freedom Funds
– Thrift Savings Plan (TSP)
Target Date (Lifecycle) Funds vs. Lifestyle Funds • Two different types of mutual funds that are often confused
due to similar names
• Both are “all-in-one” portfolios containing several different asset classes
• Target date (Lifecycle) funds have a future date in their name and automatically adjust from an aggressive to a conservative asset allocation over time
• Lifestyle (a.k.a, target risk) funds have different portfolios with different asset allocation % weightings; investors choose a portfolio to match risk tolerance level; portfolio won’t adjust over time (investors would need to change portfolios)
Target Date (Lifecycle) Funds vs. Lifestyle Funds
Lifecycle (Target Date) • Manages money toward
an investor’s future target date
• Takes the guesswork out of the process of reducing investment risk over time
• Low maintenance approach
Lifestyle (Target Risk) • Manages money
according to investor’s risk tolerance level
• Provides more consistent exposure to a certain amount of risk over time
• Requires investor decisions and action to make changes
Distinguishing Trait: Mutual Fund Name
Lifecycle (Target Date)
• Generally identified by a DATE in their title
• Examples: 2020 fund, 2030 fund, 2050 fund, etc.
Lifestyle (Target Risk)
• Generally identified by a RISK LEVEL WORD in their title
• Examples: Growth Fund, Moderate Growth Fund, Conservative Growth Fund, Income Fund (Vanguard)
Selected Trade Names Lifecycle (Target Date)
• Vanguard Target Retirement Funds
• Fidelity Freedom Funds
• T. Rowe Price Retirement Funds
Lifestyle (Target Risk)
• Vanguard LifeStrategy® Funds (4 portfolios)
• Fidelity Asset Manager® Funds (7 portfolios)
• T. Rowe Price Personal Strategy Funds (3 portfolios)
More About Target Date Funds • Also referred to as “age-based” funds
• Target date is the year an investor plans to retire and stop making new deposits to fund (+/-) 5 years
– Dates spaced at 5- or 10-year intervals (2030, 2035, etc.)
– If retiring in between two target dates, can choose one or the other nearest date or a combination of two close dates
Example: If planning to retire in 2022, could use a 2020 fund or 2025 fund or both
– If a conservative investor, “go shorter” (2020)
– If an aggressive investor, “go longer” (2025+; more stock )
Sample Target Date Mutual Fund Portfolios
More About Target Date Funds • Equity and fixed-income assets in one mutual fund
• Vanguard and Fidelity are two largest suppliers of target date funds; composition and expenses vary
– Vanguard includes passively managed (index) funds
– Fidelity includes actively managed funds
• Only make sense if they include most of your retirement investments
– Otherwise, you alter your overall asset allocation and contradict the whole premise of using TDFs
Take-Away #2: Three key performance factors are fees, underlying funds, and glide paths
Question #2: What is a target date fund glide path?
More About Target Date Funds • Have gained popularity in last decade • Popular “qualified default investment alternative”
(QDIA) for tax-deferred employer retirement plans • Typically formed as open-end investment companies • Defining characteristic is glide path, which determine
asset mix of the fund over time
More About TDFs as QDIAs • Default investments are especially important in
employer retirement plans with automatic enrollment
• Some employees who are enrolled in employer retirement plans fail to provide instructions for investing their deposits
• If workers do not select investments for their retirement account, employer puts money in the default investment
• U.S. Department of Labor approved TDFs as an appropriate Qualified Default Investment Alternative
The Glide Path is Critical! • Determines starting target date fund asset allocation
and how quickly it will change
• Generally becomes more conservative over time
• Three key elements:
– Initial equity allocation
– Slope of the glide path
– Equity landing point (i.e. date after retirement when the equity-to-fixed-income ratio remains unchanged throughout rest of retirement)
http://www.pionline.com/article/20140818/PRINT/308189983/some-target-date-funds-are-boosting-equities
Glide Paths Vary Among TDF Providers
• Glide path: how equity (stock) % changes over time; a critical determinant of wealth creation outcomes
• Found in both TDFs for retirement and age-adjusted portfolios in 529 college savings plans
• Each TDF provider establishes its own glide path and glide paths can vary considerably
• Three glide path methods: – Straight line: Steady, linear approach to gradually reduce stocks
(Vanguard and TIAA-CREF)
– Stepped: Equities allocation is periodically adjusted in stages (ING)
– Rolldown: High equity level until about 20 years before retirement and then a sharp reduction begins (Fidelity)
http://www.bogleheads.org/wiki/Glide_paths
Glide Path Illustrations Straight Line
Stepped
Rolldown
Source: http://www.bogleheads.org/wiki/Glide_paths
“To” and “Through” Glide Paths • “To” Glide Path- Assumes that retirement age is the
target date; at that point, the portfolio’s stock % and investment mix remains static
• “Through” Glide Path- The equity allocation continues to decrease for a designated number of years after retirement before leveling off
• Landing Point- The point in the glide path where the TDF reaches its lowest equity allocation
• TDFs with different glide paths and landing points have very different risk profiles
Through Retirement TDF With 25 Year Stock Landing Point
Source: U.S. Securities and Exchange Commission
Question #3: What type of glide path does your TDF have? The TSP L fund?
Take-Away #3: Performance among TDFs can vary dramatically
TDF Industry Examples http://www.wealthinformatics.com/2011/04/17/do-you-know-your-target-retirement-funds-glide-path/
Describes starting equity %, type of glide path, and equity landing point for five TDFs • Fidelity Freedom • Vanguard Target Retirement • T. Rowe Price • TIAA-CREF • ING Solution
More About Target Date Funds • As an “all-in-one” investment, should have exposure
to wide range of asset classes
– Fidelity uses 23 underlying mutual funds
– Vanguard uses 3 broad index funds
• Key factors to consider
– Fund’s investment style
– Fund’s historical performance
– Fund’s fees and expense ratio
http://www.investopedia.com/articles/mutualfund/05/051005.asp
Investment Style Target Date Fund Itself • Strategic vs. Tactical
– Strategic: Rebalance portfolio to target asset %s – Tactical: Change portfolio in response to current
market conditions Underlying Mutual Funds • Active vs. Passive
– Active: Use actively managed funds to try to outperform benchmark index
– Passive: use index funds to track a benchmark index
More About Target Date Funds • Fastest growing asset class used in employer defined
contribution (DC) plans
• Make up about 20% of DC plan market
• $670.6 billion in TDF assets in 2014
• TDF assets could double in size by 2018
• TDF suppliers include Vanguard, Fidelity, T. Rowe Price, BlackRock, JP Morgan, Principal Financial, and American Funds
http://online.barrons.com/articles/SB50001424053111904544004579651134019266274
Target Date Fund Evolution Process: 1980s-2013
• 1980s: 401(k)s become a supplemental retirement savings plan; 3-legged stool of Social Security, a defined benefit pension, and savings is still intact
• 1990s: Beginning of the “do it yourself” retirement model; more 401(k)s introduced as sole retirement plan and fewer DB pensions
• 2000s: “Do-it-for-Me” model introduced and TDFs gain popularity; defined contribution (DC) plans become primary retirement savings vehicle
Target Date Fund History • First target date funds created in 1994 by Wells Fargo and
Barclays Global Investors
• Responded to 401(k) plan participants’ failure to prudently manage their retirement plan portfolios for 10+ years
• Plan participants wanted someone to make 401(k) investment and asset allocation decisions for them
• Institutions needed to develop a strategy to use with millions of plan participants
• Participants were aggregated into age-based cohorts http://www.ucs-edu.net/cms/wp-content/uploads/2014/04/I_ABriefHistoryOfTargetDateFunds.pdf
More Target Date Fund History • 1996: Fidelity Freedom TDFs
• 2001: Principal LifeTime TDFs
• 2002: T. Rowe Price Retirement TDFs
• 2003: Vanguard Target Retirement TDFs
• 2006: Pension Protection Act (2007 for final regs) lead to increased use of TDFs in DC plans
– Created a “safe harbor” for TDFs as a Qualifying Default Investment Alternative in auto-enrollment DC plans
• 2008: Performance issues raise concerns by SEC and investors, especially for near-term (2010) TDFs
More Target Date Fund History • 2008- TDF investors and regulators became very
aware that “all glide paths are not created equally” • 2009- SEC and Department of Labor hearings on
TDFs; critics claimed TDFs were not as conservatively positioned as their names implied
• 2010- New TDF disclosure rules published by the SEC, including better description of glide paths
• 2013- 36 target date mutual fund firms; 2010 TDFs were only category to “leak” assets (retiring boomers)
• 2015- L fund becomes TSP default option (10/15) http://corporate.morningstar.com/us/documents/MethodologyDocuments/MethodologyPapers/2014-Target-Date-Series-Research-Paper.pdf
Take-Away #4: Knowing a TDF’s glide path is critical to understanding its risk profile
Target Date Fund (TDF) Advantages
• Provide diversification across asset classes
• 5- or 10-year intervals to meet a variety of needs
• Generally designed to be a continuing investment for investors during retirement
• Investors do not have to buy a fund that matches their presumed retirement date (free choice to decide)
• Can buy for taxable and tax-deferred accounts (if offered as an employer plan option)
More Target Date Fund (TDF) Advantages
• Fund managers make all asset allocation decisions
• Many TDFs have low required minimum investments (e.g., $1,000 for Vanguard)
• Increasingly being offered as default option in tax-deferred employer retirement savings plans
• Offer a “low maintenance path” for investors who don’t know where to start
• Like any other mutual fund, subject to Investment Company Act of 1940 regulation (SEC)
Target Date Fund (TDF) Disadvantages
• Do not address individual risk tolerance levels
• Do not guarantee sufficient retirement income
• As with any investment, TDFs can lose money
• Sometimes (e.g., 2008) all asset classes lose value simultaneously; 2010 funds lost 30% on average
• Two layers of fees: TDF and underlying funds
• Can’t make “apples to apples” comparisons
• Extended glide paths may leave investors exposed to more risk than they want
Take-Away #5: TDFs work best for your entire retirement savings
Other Key Points • Small differences in fees can translate into large
differences in returns over time
• Consider a TDF’s asset allocation over the whole life of the fund
• Consider a TDF’s inflation protection
• Compare the % of stock at a TDF’s most aggressive and conservative investment mix
• Consider the number of underlying funds in a TDF
• Seek out TDFs with expense ratios < 0.84% (industry average)
Future TDF Projections • Expected to hold 35% of 401(k) assets by 2019;
(13.5% in 2013 according to Cerulli Associates): http://www.wsj.com/articles/fears-about-target-funds-1425870191
• Vanguard projects that, by 2016, 55% of all plan participants and 80% of new plan participants will be invested entirely in a TDF: http://www.benefitspro.com/2012/06/26/vanguard-managed-retirement-accounts-increasing-in
Target Date Fund Resources • Investment Company Institute:
http://www.ici.org/pubs/faqs/faqs_target_date
• U.S. SEC and Department of Labor: http://www.dol.gov/ebsa/pdf/TDFinvestorbulletin.pdf
• Investopedia: http://www.investopedia.com/terms/t/target-date_fund.asp and http://www.investopedia.com/articles/mutualfund/05/051005.asp
• U.S. SEC: http://www.sec.gov/investor/alerts/tdf.htm
• eXtension: http://www.extension.org/pages/63010/monthly-investment-message:-february-2012#.VQyJak0tGM8
Before You Invest in a TDF • Examine a fund’s fees
• Review a fund’s past performance
• Understand a fund’s glide path and stock % landing point; is it a “to” or “through” retirement TDF?
• Understand a fund’s strategy and its underlying assets; are they active or passive funds?
• If in a taxable account, know the minimum deposit
• Read the prospectus!
Key Take-Aways • TDFs become more conservative automatically
• Three key performance factors are fees, underlying funds, and glide paths
• Performance among TDFs can vary dramatically
• Knowing a TDF’s glide path is critical to understanding its risk profile
• TDFs work best for your entire retirement savings
– Many investors combine TDFs with other investments
Key Take-Away Applications • Decide if the simplicity and automation of TDFs is
attractive to you and/or your clients/students
• Read a TDF prospectus to understand TDF fees, composition, glide paths
• Compare the performance of at least three comparable TDFs (e.g., three 2040 funds)
• Compare the glide path of at least three comparable TDFs (e.g., three 2040 funds)
• Consider repositioning current, unfocused retirement savings into a TDF
Key Soundbite Investors should know what they are buying because not every target date fund with the same date is the same.
Question #4: Any final questions about TDFs? Put Qs in the chat box and I’ll answer them.