Advanced Personal Finance

One of the biggest reasons people shy away from investing is because, to the novice, it’s very confusing. There is a whole universe of choices when it comes to investment options. Even if you know a little bit and narrow it down to mutual funds, there are still thousands to choose from.

To help keep things simple, I often recommend what are called, variously, asset allocation funds, lifestyle funds, or target funds. In short, these are funds of funds that do the work of asset allocation for you. You simply pick a target date (usually it’s for retirement, but not always) and let the fund manager do all the work. It’s Ron Popeil at its best - set it and forget it.

I have been remiss, though, in doing some homework on these types of funds.

It turns out that the asset allocations between similar funds among different fund companies varies wildly.

For my analysis, I looked at three different target date funds for each of the ‘Big Three’ fund companies - Vanguard, Fidelity, and T. Rowe Price. All have very similar cost structures - management fees are below 1% in all cases. All three are reputable, consumer-friendly firms. There is a striking difference, however, in each firm’s apparent risk tolerance.

Vanguard

Vanguard offers target dates in increments of five years. It also has a target fund for those already in retirement. The longest time horizon it offers is a 2050 fund.

Here’s how Vanguard’s asset allocation looks for their 2025 fund:

As you can see, Vanguard has a roughly 80%/20% stock/bond mix. I’d say, for a target date about 20 years out, this mix is pretty decent. For my taste, maybe it’s not quite aggressive enough, but that’s a small point.

What I particularly like about Vanguard’s fund is it invests in indices. Specifically, for the 2025 fund, fully 63% of the fund’s assets are in the Total Stock Market Index Fund. I like that a lot - you’re getting the whole market. If there’s anything to complain about, it’s that emerging markets only get 3% of the fund’s money - to me, a little low.

T. Rowe Price

T. Rowe Price also offers funds in five year intervals. Their 2025 fund looks like this:

T. Rowe Price has the most aggressive stock/bond balance. Fully 85% of the fund’s assets are in stock funds. International funds are 13.5% of assets. Interestingly, only US bonds are represented. T. Rowe Price’s 2025 fund uses actively managed funds almost exclusively. Only one index (S&P 500) fund is listed.

Fidelity

Fidelity has greater ‘granularity’ in its fund offering. You can choose from funds at intervals of two years. As a result, for this analysis, I used the 2024 fund as a proxy. Here’s their asset allocation:

Fidelity is the only one of the three that has anything in cash equivalents, and it holds 14% there for this fund. That’s a shockingly high number. For someone 18 years from retirement, I’d say none of their money should be in cash. Even if you look at a target 2034 fund, they have almost 8% in cash. That’s just too much.

In addition to the cash position, this fund has a less than 40% stake in equities. Again, that number is just too small for someone with almost 20 years to invest. For this reason, I can’t recommend the Fidelity target date funds. Which ain’t so great, because my company’s 401(k) plan uses them.

I was surprised by this analysis. I figured all comparably-dated funds would have more or less the same asset allocation. As this post shows, that assumption couldn’t be more wrong.

This finding kind of sucks because the big appeal of target date funds is their easy application and selection. If a novice investor still has to understand asset allocation, I think these funds have largely failed to address one of the big obstacles to beginning investing, which is really too bad.

Here’s what some other PF writers have written about target date funds recently:

• Jim at Blueprint for Financial Prosperity recommends them after you’ve maxed your 401(k) and IRA.

• Jeremy at Generation X Finance addresses target date funds generally and brings up a good point about overlap in particular.

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This entry was posted on Tuesday, October 30th, 2007 at 8:15 am and is filed under 401(k), Investments. You can follow any responses to this entry through the RSS 2.0 feed. You can leave a response, or trackback from your own site.