Is Your Target Date Fund Prudent?
- Prudence can sometimes limit performance. Such is the case in the last 10 years
- Mutual fund ratings are based primarily on performance, not prudence.
- We find that Morningstar ratings of target date funds (TDFs) reward imprudence, so we’ve developed a Prudence rating.
TDF prudence is all about glidepaths rather than performance. Performance matters, but there are time periods when prudent glidepaths are out of favor and time periods when they are in favor. It’s like value and growth stock investing in the stock market. As shown in the graph below, Morningstar ratings of TDFs favor lower prudence over higher. This is because U.S. stocks have performed very well, so a high allocation has generated high returns.
The three great benefits of target date funds are diversification and risk control provided at a reasonable cost. All three of these benefits vary widely across target date fund providers, as shown in the graph below.
Looking to the left of the graph at long terms to target date, we see consensus in high equity allocation – the lines cluster. The differentiator at long dates is diversification. Theory states, and evidence confirms, that diversification improves the risk-reward profile of a portfolio. Greater diversification leads to higher returns per unit of risk, and is a benefit of TDFs.
Looking to the right of the graph, near the target date, we see wide disagreement, with equity allocations at target date ranging from a high of 70% to a low of 20%. The prudent choice is safety at the target date, the other benefit of TDFs.
These two key benefits, plus fees, are used to create Prudence Scores.
We’ve developed Prudence Scores for the 43 most popular TDFs based on these three key characteristics. See if you can find your TDF in this list of the Top 20. If it’s not on the list, it’s not very prudent.
The Most Prudent TDF
The most prudent TDF is the one you build for yourself, customized to your needs and circumstances. Please visit www.GlidePathWM.com