They’re controversial and initially failed to perform to expectations. While this could describe many investment products currently available, it specifically refers to target-date funds. After significant adjustments to perfect their glide paths, the target-date funds growth has led to increased trust among advisors and plan participants, reflecting a positive shift in the industry’s perception of these funds.
In fact Bloomberg, citing data from Cerulli Associates, points out that in 2015, for the first time, more than half of all 401(k) contributions will go into target-date funds. It projects the assets in target-date funds to hit $2 trillion by 2019, when 88 percent of all 401(k) contributions will go into the funds.
“With 10 years of history, there’s now enough of a track record to judge just how well investors are doing in target-date funds,” the news service notes. “The average per-year return over the past decade was 5 percent, Morningstar estimates. That’s about what you would expect from funds that are a blend of stock and bond funds. Stock funds were up an annual 7.5 percent over the past decade, while bond funds were up an average 4.4 percent.”
Target-date funds are designed to slowly convert investments from high-risk, higher-return equity-like investments to lower-risk, lower-return fixed-income-like investments over time. The plan participant picks a date at which they estimate they’ll retire, usually decades in the future, and the target-date fund does the rest.
Bloomberg adds that target-date funds have one big advantage over other kinds of mutual funds, which is related to behavioral economics and plan participants penchant for sabotaging their own retirement prospects.
“The average mutual fund has a flaw, which is that the average investor hardly ever does as well as his or her funds. Investors tend to jump in and out of funds at the wrong time. They buy high, choosing funds only after they’ve done well. And they sell low, dumping underperforming funds just as they’re about to take off.”
Indeed, an oft-repeated (and startling) statistic from research firm Dalbar Inc. found that while the S&P 500 returned 12.2 percent in the roughly 20 years from 1984 through 2002, the average equity mutual fund investor earned a paltry 2.6 percent.
“Investors in target-date funds, at least so far, seem to have avoided this curse,” Bloomberg claims. “They’ve been sticking with their funds and doing surprisingly well in the process.”
On average, target-date fund investors are doing 1.1 percent better per year than their funds, the news service adds. Investors in almost every other fund category lagged their funds over the past decade, including a -0.98 percent underperformance for U.S. equity funds and -1.3 percent for municipal bond funds.
Great—so what’s the downside? Fees, for one.
“Target-date funds charged investors 0.78 percent in fees last year,” Bloomberg concludes, quoting Morningstar. “That’s down from an expense ratio of 1.04 percent in 2008. But it’s still a drag on performance, with some investors paying three or four times more than others.”
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