Dear Kirk: Does it make sense to contribute to a target date mutual fund as a part of a company’s 401(k) plan if the fees are high (>1%), or would it be better to pick investments with lower fees within the 401(k)?
Kirk Says: As with any purchase we make as consumers, it is important for us to understand what we are paying for. How many times have we purchased something only to find it at a lower price a month later or 10 miles further down the road? But the old adage You Get What You Pay For should ring just as loudly in our heads when it comes to bargain funds with low expense charges.
When evaluating target date funds, take a look at key metrics like investment returns, expenses and the measure of the concentration of stock and bond ownership, commonly referred to as a glide path. Morningstar and other investment firms normally compare groups of these funds by their series year. Let’s look at these three metrics a little more closely.
First, with investment returns, it’s important to note that past performance is not a predictor of future returns. With that in mind, do your research and look for funds that have been run by the same fund manager for at least the last five years and have beaten or matched the performance of an appropriate benchmark for the same period of time.
Second, expenses are a key to improving your performance. Fees can range from 0.17% to as high as 1.80%. Average target date fund (TDF) fees have steadily fallen over the past few years. Morningstar reports that fees fell from an average of 1.04% in 2008 to 0.99% in 2011 and then further to 0.91% in 2012. Look for this trend to continue as more and more consumers crave the simplicity of the TDF and become more demanding about their displeasure in paying the outrageous fees associated with some fund families.
Finally, be sure to look at the glide paths that the funds use to reallocate their balance of stocks and bonds as the TDF’s age. These can vary greatly. I prefer the graphical representations as opposed to looking at a chart full of numbers. Keep in mind that you are trying to strike the balance between market-risk exposure (the possibility of loss due to factors that affect the overall performance of financial markets) and longevity risk (the possibility of outliving your accumulated portfolio).
Kirk Gwaltney is a Chartered Financial Consultant and a Chartered Life Underwriter in Brentwood, Tenn. Learn more about him at kirkgwaltney.com.