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How to Evaluate a Target-Date Fund's Glide Path

Dawn Reiss

The problem with a one-size-fits-all philosophy is that it never truly fits everyone. Thanks to many employers auto-enrolling employees in a 401(k), target-date funds have grown in popularity as a catch-all retirement plan, but the funds, including those sharing the same target date, can differ dramatically.

"Each target-date manager or firm has a different philosophy," says Jeff Holt, associate director of manager research for Morningstar Research Services in Chicago.

That philosophy manifests itself in the fund's glide path, which is how the mix of stocks and bonds becomes increasingly more conservative as the retirement or target date nears. "Picking a target-date fund is like giving driving directions to get to a beach," says Brannon Lambert, an advisor with Canvasback Wealth Management in Raleigh, North Carolina. "Someone in Oregon is going to have a different route than someone in Florida. Not everyone has the same destination."

Even though all target-date funds become more conservative with time, each fund has its own outlook for how and when to do that. That's why investors should evaluate the glide path of each target-date fund series, Holt says. All the funds in one series, such as Fidelity Freedom or T. Rowe Price Retirement, have similar glide paths, and the same fund family may have more than one series of target-date funds with different glide paths. For instance, the T. Rowe Price Target series has a different glide path than T. Rowe Price Retirement.

[See: 7 Tips for Finding the Best Target-Date Retirement Funds to Buy.]

Funds with target dates that are 40 years out may look similar, especially funds of the "big three" -- Vanguard, Fidelity or T. Rowe Price -- as all invest more than 70 percent of assets in stocks at that stage, says Holt, who authored Morningstar's 2017 Target-Date Fund Landscape report. The funds look the most different as the retirement date approaches, he says. "That's also the most important time because that's when an investor's assets are at or near their peak, and they become notably different depending on what target-date series you are in."

For example, one target-date fund may have 10 percent invested in stocks at retirement while another will have 60 percent, says Jeff Elvander, chief investment officer of NFP Retirement in Aliso Viejo, California. "There is no one silver bullet," Elvander says, even though the ultimate goal -- retirement -- remains the same.

Choose a glide path, not a target date. There are two types of glide paths: those that go "to" the target date, when the fund typically keeps the same asset mix throughout retirement, and those that go "through" the retirement date, with asset allocations that continue to change. Funds that glide through the target date account for something many investors overlook: the potential for a long retirement, which may require more aggressive asset allocations for longer periods, says Erika Jensen, president of Respire Wealth Management in Houston.

For example, if you own a 2030 fund with a "to" glide path, the investment mix will flatline in 2030 at its most conservative allocation, she says, but "if you own a 2030 fund with a 'through' glide path, you'll see the investment mix becoming more conservative well beyond the year 2030."

To determine which glide path a target-date fund has, check the fund's prospectus or fact sheet, Jensen says. All funds have a written investment policy, usually found in the summary description or as a chart on its fact sheet.

Then decide whether that glide path is for you. Most 401(k) plans won't let you choose between funds with "through" and "to" glide paths, she says. If you want to customize your fund, review the fact sheets and then choose a different target date that's more in line with your desired glide path, Jensen says.

[See: The Best ETFs Retirees Can Buy.]

Study the fund's holdings. Think of your target-date fund as a multi-layered cake. Look at the mixture of stocks and bonds, as well as sub-asset classes like U.S large-, mid- and small-cap stocks, emerging markets and Treasury inflation-protected securities (also called TIPS), a type of bond used to hedge against inflation.

Lambert says investors should find out when the fund will change its asset allocation and to what percentages. See if you're comfortable with the allocations the fund's glide path will require, particularly the percentage invested in stocks in retirement, and then compare glide paths from different firms to get a sense of how they are positioned, Holt says.

Many target-date funds are too heavy into stocks for older investors and ignore valuations, says Michael Chadwick of Chadwick Investment Advisors, based in Unionville, Connecticut. Investors should ask if the fund uses any valuation metrics or if allocations are simply asset class decisions. "If it's mostly the latter, it's a huge problem for the investor," Chadwick says. "The big issue here is the current asset bubble we're in. Stocks and bonds are grossly overvalued, and the world is following this target-date and index approach. It's going to be a train wreck for investors over the next 10 to 15 years."

Because most target-date funds are simply a fund of funds, costs can be layered, Lambert says. He suggests asking what the fund costs and what the costs are for the underlying mutual funds in which the target-date fund invests.

Also ask if the target-date fund only invests in its own family of funds or does it allow for non-proprietary funds? "Most target date funds only invest in their own family of funds, which means they are simply funneling business to themselves instead of looking to find the best fund for each asset class," Lambert says.

Look for anomalies. Because the goal of a target-date fund is to provide diversification and a professional for managing allocation, investors should consider if the holdings include any outliers. "You want to understand if there are significant differences in your fund and the typical peer," Holt says. Outliers aren't necessarily a problem, but you should know why the glide path drives the fund to include these unusual holdings and see if you're comfortable with that strategy.

For example, the Vanguard Target Retirement 2045 fund (ticker: VTIVX), to which Morningstar gives a gold rating, tends to hold more international equities than some of its target-date fund peers and ventures more into international bonds as the target date approaches. While other funds typically allocate a third of equities to non-U.S. stocks and 15 percent of fixed income to foreign bonds, Vanguard increased its international stock holdings to 40 percent and foreign bond exposure to 30 percent in 2015 to become more globally diversified, Holt says.

Some funds like those Vanguard runs only invest in index funds, Holt says, whereas other target-date funds like Fidelity Freedom, J.P. Morgan SmartRetirement and T. Rowe Price Retirement invest predominantly in actively managed funds.

Know who's in charge. Like actively managed funds, target-date funds are led by one or more portfolio managers. You want consistent leadership without a lot of turnover, Holt says. Ideally, there hasn't been a management change in five or more years, and the fund is led by a research-backed team that can carry on the same investment philosophy no matter who is in charge. "The decisions the managers make will have a big impact on the glide path and asset classes, which will have a ripple effect into the performance of the fund," Holt says.

[See: 10 Ways for Investors to Buy the Market.]

His other tip: Find out which other investments the managers run to get a sense of how much attention they may be giving to the target-date funds. You don't want to invest in any fund that a manager considers an afterthought.



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