How to Pick a Target Date Fund, Part 2: Looking at Glide Path
At the end of my previous post, How to Pick a Target Date Fund, I urged readers to "look under the hood" of target date funds to understand the funds' current asset allocation between stocks, bonds, and cash. That post looked at three popular target date funds and showed that those funds -- Fidelity, T. Rowe Price and Vanguard's 2020 target date funds -- have significantly different asset allocations.
Now let's examine another important aspect of looking under the hood: the glide path of a specific fund as it moves over time into more conservative investments. It's actually pretty easy to understand, based on my conversations with fund representatives. For instance, suppose you're invested in a 2020 target date fund. In five years, the asset allocation of your 2020 fund will change and look like today's asset allocation for the company's 2015 fund. Most mutual funds families adjust the asset allocation frequently, sometimes daily, as they march towards their asset allocation milestones.
So let's revisit the 2020 target date funds of Fidelity, T. Rowe Price and Vanguard that I analyzed in my prior post. In ten years, the asset allocation of these 2020 target date funds will look like today's asset allocation of their 2010 funds. Here are these funds' asset allocations as reported by Morningstar:
Eventually, the asset allocation of these target date funds will converge to the current asset allocation of the mutual fund family's retirement income fund. For the mutual fund families that we're examining, these are Fidelity's Freedom Income fund, T. Rowe Price's Retirement Income fund, and Vanguard's Target Retirement Income Fund. Let's take a look at these funds' asset allocations:
This post and my prior post show that Fidelity's target date funds are the most conservatively managed, with the highest allocations to bonds and cash, while T. Rowe Price's target date funds are the most aggressively managed, with the highest allocations to stocks. This isn't meant as a judgment on any of these mutual fund families. Instead, it just reinforces the idea that you should decide on the asset allocation and glide path that's right for you, and then pick the target date fund that has these features, instead of just relying on a number on the calendar to guide your decision.
Of course, you should keep in mind that a specific mutual fund family can change its mind about the appropriate asset allocation and glide path for a specific target date fund. Many target date funds came under scrutiny as a result of the recent meltdown, so it's possible that they might change their asset allocations in the future. As a result, it's a good idea to continue paying attention to how your target date fund is managed.
This post and my prior post covered the situation where you're offered a lineup of target date funds in your 401(k) plan and your only decision is the specific target date fund to select in this lineup. A future post will examine additional considerations when you have the opportunity to choose among many target date funds offered by different mutual fund companies. In this situation, there's even more to look at under the hood!
