Retirement Savers Should Benefit From Declining Target-Date Fund Fees

NEW YORK (TheStreet) -- Many target-date funds have been slashing fees.

Allianz Global Investors recently reduced its expenses from 0.91% to 0.64%, while Nationwide NFS cut costs from 0.64% to 0.42%.

Companies such as Fidelity Investments and TIAA-CREF have introduced index funds with expense ratios less than 0.50%. The average expense ratio of the target funds is 0.72%, according to BrightScope.

The reductions are important for retirement savers because the target funds are staples in many 401(k) and IRA accounts.

Target-date funds are designed for people who will retire around a certain year, such as 2020 or 2040. These funds, which have diversified portfolios of stocks and bonds, have been embraced by employers seeking convenient choices for 401(k) plans. At many companies, target-date funds are now default choices; if employees take no action, money is automatically withdrawn from their paychecks and deposited into target funds.

In recent years, money has flowed into target funds, which now have $431 billion in assets, according to Ibbotson Associates.

As more participants have invested in target funds, employers have become increasingly concerned about maintaining low fees.

The emphasis on fees is likely to increase because of new 401(k) disclosure rules. Starting this fall, employees will receive written statements in the mail detailing the costs of the plans.

The statements could be an eye-opener for many plan participants, says Eddie Alfred, BrightScope's vice president of data and research.

"A lot of people don't think they pay any fees at all for their 401(k)s," he says. "It could be a rude awakening when they suddenly see that they are paying 1% or 1.5% of plan assets in fees."

Average expense ratios could fall sharply in coming years because companies are introducing target funds that invest in low-cost index mutual funds and exchange-traded funds. New entrants include BlackRock Lifepath Index Portfolios and Lincoln Advisors Presidential Protected Profile Funds.

Index funds track benchmarks such as the S&P 500. Because they make no effort to outdo the markets, index funds can come with low costs. In contrast, actively managed funds must charge more to support analysts and portfolio manager who seek to outdo benchmarks.

The leader in passive target funds has long been Vanguard Group, which charges 0.19% on some of its funds. Lately Vanguard has been attracting strong flows into its funds as more investors have abandoned active funds and shifted to passive choices.

The growth at Vanguard has encouraged competing target funds to lower fees and shift to passive strategies, says Eddie Alfred of BrightScope. "Vanguard has had the lowest fees in the institutional target-date field," Alfred says. "Other companies are making changes to meet the low-cost challenge."

Fidelity Investments introduced passive choices that match the Vanguard fees. Fidelity Freedom Index 2030 FXIFX charges 0.19%. In comparison, Fidelity Freedom 2030 FFFEX , which uses active funds, charges 0.71%.

While many target funds hold collections of eight or more funds, Vanguard takes a simple approach, investing in just a few funds.

Vanguard Target Retirement 2050 VFIFX has about 63% of its assets in Vanguard Total Stock Market Index VTSMX , 27% in Vanguard Total International Stock Index VGTSX and 10% in Vanguard Total Bond Market II Index VTBIX .

"Target-date funds should be as straightforward as possible because they are designed for people who may not be deeply engaged in the investing process," says Scott Donaldson, a senior analyst in Vanguard's investment strategy group.

TIAA-CREF Lifecycle Index 2050 TFTIX has investments in four funds. In contrast, the company's actively managed 2050 target-date fund has investments in 14 funds. The extra holdings may provide diversification, but they also come with higher fees.

This article is commentary by an independent contributor, separate from TheStreet's regular news coverage.

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