Target-date funds have become a popular hands-off investment choice. And a recent study shows that investors who use these funds are coming out ahead.
According to Morningstar, investor returns — which take into account investor contributions and are a better measure of earnings — averaged 6.1 percent annually in target-date funds over the past 10 years. Target-date funds’ total return was just 5 percent annualized.
In other words, investors are getting the most of the funds’ returns and then some.
That is in stark contrast to many other mutual fund categories. Among U.S. stock funds, for example, the average investor return was 6.5 percent annually for the same 10-year period vs. 7.5 percent for the average fund return.
Target-date funds own a mix of stocks, bonds and other investments appropriate for a set retirement date. Over time, the balance is adjusted to become more conservative as the retirement date nears.
Many retirement plans offer target-date funds as the default option for workers, and that may be one reason why investors are reaping big rewards.
“Investors have a strong tendency to buy high and sell low,” said Janet Yang, a Morningstar analyst and co-author of the study. “With target-date funds, investors are putting in money every two weeks or twice a month. And they haven’t shown a tendency to take money out when stocks tank, like in 2008 and 2009.”
Another thing that’s helping target-date fund investors is lower fees. According to Morningstar, expenses have been declining steadily. In 2014, the average annual fee, known as an expense ratio, was 0.78 percent, down from 0.84 percent the year before and 1.04 percent in 2008.
In February, Vanguard, the largest target-date fund provider, announced it would offer a new lineup of target-date funds to retirement plan sponsors with annual fees of 0.10 percent. Currently, Vanguard charges investors outside of a 401(k) plan 0.16 percent to 0.18 percent.
Not every target-date fund is created equal, however. While expenses are coming down across the board, some annual fees still top 1 percent. And one 2020 target-date fund can be very different from another 2020 fund.
Keep in mind, too, that investment strategies can change. In addition to lowering fees, Vanguard is raising its stake overseas. By year-end, target-date funds will invest as much as 40 percent in international stocks, up from 30 percent today.
Carolyn Bigda writes for the Chicago Tribune.