Your Target Date Fund is not great
In a previous post, I mentioned that Guideline doesn’t use Target Date Funds in its portfolios. Here’s why.
At Guideline, we’re on a quest. Our mission: to battle the overall expense ratio for our plan participants — employees who are trying to save towards a successful retirement. We need to do this in the most economically responsible way possible. We are an ERISA 3(38) Fiduciary, so everything we do is and has to be in the best interest of the participant/beneficiary. To that end, we have our own in-house investment committee; they create managed portfolios that are appropriate for our customers and are adjusted as events happen in a person’s financial ecosystem.
That’s our solution, but let me explain a little more about Target Date Funds. Target Date Funds are essentially funds of funds. They consist of mutual funds themselves, and those mutual funds have their own expense ratios. When you look at the overall expense ratio of a Target Date Fund, it includes the mutual fund expense of those funds that it holds. The average Target Date Fund had a 0.73% expense ratio in 2015, according to a report by Morningstar, a leading provider of independent investment research.
Why are fees so high? In addition to the fees charged by the funds that make up target date funds, there’s typically an additional administration fee of 0.10 to 0.15%. That’s the take for managing the allocation of mutual funds inside of the Target Date Fund over time, as you approach retirement. The financial industry calls the shift towards more conservative funds over time the “glide path.” The allocation is solely based on your retirement time horizon — the number of years you have left before you plan on retiring.
But your age is just a single data point; it’s a good one, but it’s not as effective as using your retirement time horizon in conjunction with other metrics, like risk tolerance, lifestyle, savings in taxable accounts, spending habits, other existing assets, compensation changes and events, etc.
Most conventional Target Date Funds from a company (Fidelity, T. Rowe Price, etc.) also exclusively use mutual funds from that same company, which means they may not hold the best fund for a particular category. At Guideline, that’s not a concern; we’re not wedded to any individual fund manager and can use the best funds as appropriate.
Here’s where it gets tricky. Target Date Funds have their place: In my opinion, they’re an acceptable choice for people who are in a “set it and forget it” mindset — those who want to be hands-off, who don’t have a Guideline 401(k). I would much rather have a Target Date Fund than additional wrapped fees from an outside vendor, like so many of the other 401(k) providers charge. A Target Date Fund charging approximately 10–15 bps on top of a mutual fund is a much better deal than a plan administrator who charges you 50 bps and doesn't add much value. At least you know the Target Date Fund is managed by professionals — that’s a value-add and should be compensated.
As a point of comparison, we charge participants no fees, and our blended fund portfolios have fees of just 0.06%.
In the end, Target Date Funds have a place in the investing world, just not in your Guideline 401(k). Guideline provides responsible portfolios to our customers utilizing similar mutual funds as those used in Target Date Funds, and we eliminate the additive fund expense charged by the manager of the Target Date Fund — another 0.10%–0.15% knocked off that final expense ratio.
Similar to target date funds, we automatically rebalance participating employees’ portfolios to keep them on track with their asset allocation. Since a 401(k) is a tax-deferred retirement account, there are no tax implications for rebalancing and Guideline does not charge a fee for rebalancing.
We’ll continue to bring transparency to the 401(k) industry. Please don’t hesitate to contact us at [email protected].