Key Takeaways
- Target-date funds take rebalancing off the hands of the investors.
- When a target-date fund rebalances, it will trigger a taxable event for taxable accounts.
- Your brokerage or asset manager may charge additional fees if you invest in outside target-date funds, which may decrease the value proposition of your portfolio.
- You should consider your risk tolerance, underlying funds, and portfolio fees before investing in a target-date fund.
- Vanguard Target Retirement is relatively cheap, has a standard glide path, and a broad asset mix.
- The iShares LifePath Target Date ETF series is the only target-date exchange-traded fund available, is broadly diversified, and has a forward-thinking approach to asset management.
- T. Rowe Price Retirement is predominantly actively managed and a better fit for someone with a higher risk tolerance.
Susan Dziubinski: I’m Susan Dziubinski with Morningstar. We’re in the thick of tax season, which means many investors are making IRA contributions, and target-date funds can be ideal IRA investments. Here to discuss why that is and to share a few of Morningstar’s favorite target-date funds is Jason Kephart. Jason is a senior principal with Morningstar’s manager research team. Hi, Jason. How are you?
Jason Kephart: Good.
Benefits of Target-Date Funds in a Portfolio
Dziubinski: Let’s get right into it. You know, Christine Benz, who both you and I have known for years, she’s Morningstar’s director of financial planning. She’s been saying for years that target-date funds are these great investments for an IRA because, if investors choose the target-date fund that fits their time horizon, then that IRA sort of effortlessly fits in with the rest of a portfolio. Delve into that a little bit more.
Kephart: Target-date funds are really just a great set-it-and-forget-it for investors who don’t want to spend a lot of time thinking about, well, how much of my portfolio should be in stocks versus bonds? How much should be in US stocks versus international stocks? What funds should I pick to fill those buckets?
The target date really takes all that off the hands of investors. Then, the other beauty of it is the regular rebalancing for you, so your portfolio doesn’t get out of whack. Then, as you age and get close to retirement, they’re generally rebalancing, so that your portfolio is getting a little bit more conservative because you don’t want to have a lot of risk at retirement, but you do want to have a lot of risk when you’re young and have a huge time horizon in front of you. This takes care of all that for you, so target date, really a great option for anyone who doesn’t want to spend a lot of time doing that and would rather do something better, like watch football.
Target-Date Funds in Taxable Accounts
Dziubinski: There you go. Now, Vanguard was in the headlines lately after making some pretty sizable distributions from some of its target-date funds. Although Vanguard’s distributions maybe were pretty big, target-date funds, in general, aren’t really great investments for taxable accounts. Talk a little bit about why.
Kephart: They’re predominantly designed for 401(k) plans, which is most of where the assets are, and these are tax-advantaged accounts, like an IRA, so they’re not really thinking about taxes. So, the bond portfolio, which tends to be taxable bonds, so that income’s taxed at an ordinary rate. Also, we talked about the rebalancing. What rebalancing does is you sell your winners and buy your losers, and anytime you’re selling your winners, that’s going to trigger a taxable event. In a 401(k) or an IRA, you don’t really have to worry about it. In a taxable account, it could be kind of a headache.
Should You Shop Around When Choosing a Target-Date Fund?
Dziubinski: Jason, you know a lot of investors already have a relationship with a brokerage or an asset manager, in particular, so can they feel pretty comfortable or confident just going with whomever they already have that existing relationship with, or does it pay to shop around?
Kephart: I think it always pays to look at your options, but I would caution that a lot of brokerages will take steps to steer you toward their own offerings, which may mean some additional fees may be charged if you pick a different target-date fund, and that might kind of kill the value proposition because you don’t want to pay any extra fees than you have to. What we’ve seen with target-date funds is the return differences can be fairly narrow, so if you are adding on additional fees, that could make a significant difference.
Key Questions for Investors Before Investing in a Target-Date Fund
Dziubinski: What are some of those key questions that investors should be asking before they invest in a target-date fund?
Kephart: I think you want to know what the glide path looks like and whether or not it fits your risk tolerance at different stages in life. This could be very difficult to know early on. A 25-year-old probably isn’t going to have a good sense of what their risk tolerance is going to look like at 60, but the shape of the glide path really does matter.
You also want to understand what the underlying funds are. Are they index funds, actively managed funds, or are they kind of a combo of both? Maybe you have a preference there.
I think the other thing you want to think about is the fees. I mean, fees really matter, particularly in an IRA where you may not have the benefit of getting the cheapest share class like you would through a company 401(k). So, I think keeping that in mind is important.
Why Invest in Vanguard Target Retirement?
Dziubinski: It’s time to name some names, Jason. You’ve brought us today three target-date series that Morningstar likes. The first one is that Vanguard series, Vanguard Target Retirement. Is this all index funds?
Kephart: Yep, it’s all index funds. I think it’s really important to remember that even though there have been a lot of headlines over the capital gains exposure, Vanguard’s target date is still a really good option for everyone. It’s probably the benchmark by which all other target-date funds are judged. That doesn’t mean they’re necessarily the best, but it is a really good option if you can get access to it, super cheap, 8 basis points no matter which vintage you pick, and it is a really sharply made glide path, I think. The asset allocation’s all index funds, so you don’t have to worry about the active managers underperforming. You basically are going to get the market return that you would expect from the portfolio, so it does fit what people would expect, which I think is also really important because I think one thing that might make people sell a target-date fund when they shouldn’t is performance that doesn’t really match what they see in the market. That’s something you don’t really have to worry about with the index-based ones.
Glide Path for Vanguard Target Retirement
Dziubinski: You touched on the glide path. Talk a little bit about how aggressive this series is in terms of its glide path or its asset mix.
Kephart: Its glide path kind of falls in line with the industry. I don’t know if that’s because everyone wants to be like Vanguard or kind of starts with Vanguard and makes changes from there, but it starts around 90% equity at the beginning, and then at retirement, it’s around a little over 50%, which I think that’s where you have really to think about the risk-tolerance part. Is 50% equity more or less than you’re really comfortable with at retirement? That’s something I would think about when choosing the Vanguard one.
Breakdown of Vanguard’s Asset Mix
Dziubinski: And then, anything about its asset mix?
Kephart: It’s the broadest base of asset mix you can get. It’s emblematic of Vanguard. You get Vanguard Total Stock Market VTSAX, Vanguard Total International Stock Market VTIAX, Total U.S. Bond Market VBTLX, and then Total International Bond Market VTABX, so you really are covering pretty much the globe. The asset classes that are missing would be high-yield bonds, which I think in a diversified portfolio may not add as much benefit as they might look like they do on their own, just because they do have some equitylike risks of using a bond portfolio. It might be a little bit riskier than you think, but you’re generally getting access to all the market-cap-weighted securities in the world.
Dziubinski: All right. At a good price, too.
Kephart: Yeah.
Dziubinski: All right, so then I’m assuming is that the biggest selling point? Is that why you really like it, that broad diversification at a low cost?
Kephart: Yes. Super broad diversification, low cost, no frills. It’s going to deliver what you think it’s going to deliver, so I think that makes it easy to own, and it’s going to deliver for people over the long run.
Overview of iShares LifePath Target Date ETF
Dziubinski: All right, Jason, so the second target date we’re going to talk about today is actually an ETF, iShares LifePath Target Date ETF, assuming this one also focuses on index funds. I didn’t even know that there was such a thing as a target-date ETF. Tell us about this one.
Kephart: It’s the only target date ETF available. It was launched in 2023 and, although it is new, it does follow the same glide path and asset-allocation framework as BlackRock LifePath Index, the mutual fund version that’s been around for more than a decade. So, even though it’s a new fund, it’s not really a new fund. It’s more of a new wrapper, but what makes the wrapper interesting is that you get it at a very low cost. Expenses are going to range around 10 basis points for the whole series. Also, you get a really interesting glide path. Vanguard’s starts at 90%; iShares LifePath starts at 99%. It starts a little bit more aggressive when you’re younger and, arguably, younger people can afford to take more risk early on, so I think I like that component of it.
Then, as you get close to retirement, it actually goes to 40%, which is pretty low, lower than the average target-date fund. But again, what you want to do near retirement is lower the range of outcomes, and the way you do that is by having less equity exposure because that’s going to lead to less volatility, so you have a little bit more certainty heading into retirement with this series. That’s one aspect I do like.
Within the portfolio, it’s index-based, all ETFs. It is broadly diversified, too. They’re a little bit more granular in their exposure. Instead of using very big, broad index funds, they have more granularity, which I think lets the managers have a little bit more viewpoint in the portfolio. We do think the BlackRock Multi-Asset team is really good, so letting them have those viewpoints we see as a benefit.
Asset Mix for iShares
Dziubinski: From an asset mix standpoint, they’re still kind of covering the waterfront, similar to Vanguard in terms of what you’re going to get exposure to if you’re invested in it, right?
Kephart: You’re getting a broad global stock exposure at the end of the day, a lot of different fixed-income exposure, so there is a lot of diversification there. They’re really smart about it. Again, high-yield bonds aren’t a part of the mix here, so you do get really bond portfolios that kind of act more like bonds, which is sometimes a good thing, most of the time a good thing, 2022 kind of an exception there, but I think, going forward, bonds are in a much better place than they were, so having that high-quality bond exposure should help also reduce volatility.
Driving Factors for iShares’ High Morningstar Medalist Rating
Dziubinski: This one actually gets a Gold Medalist Rating from Morningstar, and we just don’t hand those out to every security, so what’s the driving factor behind that very high rating for this one in particular?
Kephart: It’s a combination of low fees. I mean, obviously, that matters. Also, we just have a very high confidence in the team’s ability to execute its process. The things I pointed to in the glide path, I think also our bonus for it in terms of the process, and the team has just really shown a more forward-thinking approach to asset management than I’d say the average target-date fund.
Is T. Rowe Price Retirement Active or Passive?
Dziubinski: Jason, so the last target date we’re going to talk about today is from T. Rowe Price. It’s T. Rowe Price Retirement. Is this active or passive?
Kephart: We say active-based. They’re predominantly active management. It’s all T. Rowe funds. They do have an index fund in there, though, which helps control cost a little bit. But, generally, what you’re buying it for is the T. Rowe Price active management component, which really is going to help drive returns.
How Does T. Rowe’s Target-Date Series Compare?
Dziubinski: Jason, tell us a little bit about how the T. Rowe target-date series, how its glide path and asset mix compares to what you told us about the iShares and Vanguard options.
Kephart: T. Rowe is probably the best fit for someone who has a bit more risk tolerance than someone in the Vanguard or iShares series. It starts out at around 98% equity, but then, instead of getting closer to 40% like the iShares one does at retirement, its equity exposure stays a bit elevated, over 50%, and its bond portfolio tends to take on more risk than you would see in an index-based target-date series. So, you have more growth opportunity, for sure, but you also do have to be aware of that kind of risk, particularly around retirement. I think that’s when people are probably the most risk-averse, so that’s something you really, I think, have to be content with when you are using the T. Rowe series.
Why Pick T. Rowe Price Retirement?
Dziubinski: ason, wrap up by telling us why T. Rowe Price Retirement is one of your picks today.
Kephart: Similar to the other target dates we talked about, the multi-asset team, we have a high degree of confidence in. They’ve since shown a lot of sharpness over time. They’ve made changes that really make sense.
Then, also, I think the underlying funds, you really have to give a lot of credit to them, too. If we didn’t have a high degree of confidence in T. Rowe’s equity and fixed-income managers to deliver, then this series wouldn’t be as appealing, but because they are such a notable active equity manager and active fixed-income manager, I think that helps raise the bar for it.
Dziubinski: Well, Jason, thank you for your time today. I guess I need to go open my IRA and get it invested in a target date.
Kephart: Good luck with that.
Dziubinski: Thanks. I’m Susan Dziubinski with Morningstar. Thanks for tuning in.
Watch Maybe You Shouldn’t Delay Taking Your Social Security Benefits After All for more from Jason Kephart.
