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Monday, June 21, 2010

Target Date Funds-Should You Do It Yourself?

Is it worth constructing target date fund yourself?

Target date funds attract many investors. Pick a desired retirement date and the fund does the rest. It diversifies assets and rebalances to a more conservative position as the retirement date approaches. Some use low cost ETFs. What's not to like?

For one thing it may be worth checking the returns and the fees. If the fund charges fees and then fees are charged on the ETFs you are subject to a double layering of fees - the fund of funds effect. Thus. even though low cost ETFs are used the fees mount up.

Secondly, the performance needs to be monitored. Maybe a simpler approach gives comparable or better returns.

Analysis

Some target date funds (CLICK to ENLARGE)



I decided to take a closer look at the 2020 target dated fund and looked at constructing a fund with the same allocation based on the Blackrock diversified portfolio. The allocation is 69% equity/31% bonds. Suppose we construct a portfolio similar to the 2020 target fund based on the Blackrock diversified portfolio. How has it performed over the past 12 months?

Index

ETF Ticker

Weight (%)

1 year Return (%)

Yield (%)

Total Bond Market

AGG

30

9.18

3.71

EAFE

EFA

11

12.85

2.85

Russell 2000

IWM

11

32.62

1.12

Russell 1000 Growth

IWF

24

23.96

1.39

Russell 1000 Value

IWD

24

26.98

2.07



The portfolio return here for the year was 19.83%. The return on the 2020 fund was 17.92%.

This, of course, is a bit of "apples vs. oranges" because the allocations are a bit different but still the magnitude is sufficiently large to investigate further. Part of the discrepency may be due the higher fees incurred by the target dated fund.

Data is from Bloomberg site. Although believed to be accurate it cannot be guaranteed. Analysis is for educational purposes. Readers should do their own research or consult with advisor before investing. Writer holds these ETFs.




3 comments:

  1. There is a great target-date investment option for investors at folioinvesting. MarketGlide target date portfolios use a methodology that derives the market average glide path and implements it with passive ETFs. They are rebalanced quarterly and have no additional fees other than folio execution. Visit: https://www.folioinvesting.com/rtg/marketglide-portfolios.jsp

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  2. I agree with your assessment. I do prefer to handle my own asset allocation and am glad to to see two things 1) that the DIY model performed better and 2) I own two of the ETFs that you used in your simulation. Regards,

    Shawn

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  3. @Dirk
    Thanks for the info. I'll definitely check it out.
    @Shawn
    I have to say I was surprised at the size of the discrepancy. The thing I don't like about target date funds is that if you go to 3 different providers they all have very different asset allocations. To me this says it is better to customize asset allocation.
    What I hadn't thought of previously is that it is a fund of funds approach which adds to the expenses.
    I hope you checked out the Blackrock diversited portfolio link. I think you'll like it. I like to use it as my basic model with a few tweaks here and there.

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