Target Date Fund Indexes
The answer to the question “Does my Target Date Fund (TDF) produce competitive performance?” requires the answer to another question, namely “Relative to what?” Is there a performance benchmark you can use that provides a realistic performance comparison?
There are several TDF indexes that you can choose from. It’s important that you choose the one that is most similar your TDF so you have an apples-to-apples comparison. For example, you would not want to select a TDF index that is 75% invested in stocks if your TDF was 35% invested in stocks. TDFs benchmarks should have similar asset allocations so the comparison is more meaningful.
The key characteristics of TDFs are diversification and risk control, preferably at a low price. For example, a TDF may invest in several Exchange Traded Funds (ETFs) that in turn invest in hundreds of securities. Risk control is a function of the TDF’s glide path that gradually reduces risk as you approach your target date (the year you retire).
Diversification and risk management are the two main drivers of the performance of our TDF.
Two Common Goals
Surveys of 401k plan participants, trustees, and their consultants conclude that all three want:
- Very broad diversification
- Very low risk near retirement
A recent MassMutual Retirement Savings Risk Study examines plan participant risk preferences in 401(k) plans and finds that 85% prefer safety over higher performance as they near retirement. They want to be protected. There is nothing worse than a substantial market decline the year they plan to retire.
Consultants agree. Pacific Investment Management Company (PIMCO) conducted another survey entitled the “2018 12th Annual DC Consulting Support & Trends Survey”, in which consultants say that they would not want to see those near retirement lose any more than 10% of their savings at or near their retirement date..
There are three indexes that you should follow to benchmark the performance of your Target Date Fund:
- The SMART Indexes were the first, launched in 2007. They are modeled to preserve savings through to the target date.
- In 2008, the S&P TDF Indexes were launched. They are consensus indexes, calculated by aggregating the performance of most of the TDF mutual funds on Morningstar
- Morningstar Indexes are the most recent, launched in 2009. They are also modeled to maintain constant combined risk of human (earning power) and financial capital (investments).
The “Monopoly Index”
Vanguard has a monopoly on “Passive” TDFs. Their $750 billion of assets constitutes 90% of the market for TDFs that are comprised entirely of passively managed index funds. Vanguard has succeeded as the low cost provider, and has become a de facto standard because passive investing is a form of index.
Vanguard is a standard for low cost investing, and the SMART Index is a standard for prudent investing, as shown in the next section.
Matching Index Glide Paths to Objectives
The following graphic compares the Indexes to the preferences expressed in surveys. As you can see, objectives are most in line with the SMART indexes in the “Risk Zone” that spans the 5 years before and after retirement, the most critical part of every glide path.
Mutual Funds vs Portfolios
TDFs are mutual funds, which make them a one-size-fits-all investment alternative. If you dig a little deeper into a particular Target Date Fund, you may find it does not meet your specific requirements. An alternative is a Target Date Portfolio (not a fund) that can be tailored to your specific goals, requirements, and circumstances. GlidePath Wealth Management provides this service to people who are accumulating retirement assets outside 401k retirement plans or are already retired.
About the Author: Ron Surz is CEO and CIO of GlidePath Wealth Management an innovative money management firm that uses a patented investment process to invest retirement assets that are held outside qualified retirement plans. GlidePath manages Target Date, Invest-for-100, Special Situations and Recession Protection Portfolios.