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Target Date Index Funds

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Choosing Target Date Index Funds for the Cost-Conscious Investor

If you’re the kind of investor who values keeping costs low through passive index funds but also wants the convenience and diversification of an all-in-one Target Date fund, you’ve come to the right place. Today, we’re diving into my two favorite contenders in the Target Date index funds arena: State Street Target Retirement funds and Schwab Target Index funds.

Both fund series invest in underlying passive index funds that track different asset classes like U.S. stocks, international stocks, bonds, and real assets. This gives investors broad diversification at a low cost compared to actively managed target date funds. However, they have some key differences in their glide paths and underlying fund asset class holdings that might make one a better fit for your retirement game plan.

So let’s dive in and explore these two contenders, so you can pick the right target date index fund to help meet your retirement investing needs and goals.

In This Corner: State Street Target Retirement Funds

The State Street Target Retirement funds play the long game with a “through” glidepath approach. This means they keep a relatively higher equity exposure even after the target retirement date, which can help your money last longer during retirement. Think of it like a seasoned baseball pitcher who still has some heat left in his arm well into the late innings.

For example, the State Street 2060 fund kicks off with a 90/10 mix of stocks to bonds, aiming to maximize wealth accumulation with a heavy 90% allocation to global stocks. As you approach retirement age, the fund gradually increases its fixed income and real asset holdings to reduce risk and smooth out the ride. At the retirement target date, it still keeps about 50% in equities and real estate.

Even the State Street Income fund for retirees keeps a healthy 35% in equities and real estate and 65% in bonds and other defensive assets 5 years after your retirement date. The idea is to provide income while still giving you a shot at growth opportunities. This approach recognizes that retirement is a marathon that can last 30 years or more.

State Street’s well-diversified allocations include large and small/mid U.S. stocks, international developed markets, and emerging markets. On the bond side, they mix in core investment-grade bonds, high yield, global bonds, inflation-protected TIPS, and real assets like REITs and commodities. This multi-asset strategy can help enhance overall risk-adjusted returns, much like a well-balanced sports team that excels in both offense and defense.

In The Other Corner: Schwab Target Date Index Funds

Schwab’s glidepath also uses a “through” approach, however it is even more aggressive for younger investors, starting off with a whopping 97% in global stocks. It’s like a young quarterback with a rocket arm, taking deep shots downfield to rack up yardage early on. As retirement gets closer, Schwab gradually increases fixed income to about 50% at the target date. The big difference from State Street is that it reaches the landing point of 35% equities 20 years after your retirement date.

This aggressive glidepath is designed for maximum growth potential during your long accumulation phase. Schwab’s equity allocation includes large and small U.S. stocks, developed international markets, emerging markets, and real estate (REITs), but leans more towards domestic stocks in the younger funds. On the fixed income side, you get a mix of short-term Treasuries, aggregate investment-grade bonds, and TIPS for inflation protection.

Compared to State Street, Schwab has less exposure to “real assets” like commodities and less credit risk in bonds by avoiding high yield. Schwab’s glide path and underlying funds are more plain vanilla than State Street’s multi-asset approach. While it is less diversified than State Street, it could be a good choice for young investors looking to keep fees low and focus on growth.

The Winner For You

So which of these index Target Date index funds should you choose if you are a cost conscious investor?
Here’s my take:

For Young Accumulators

The Schwab Target Index funds are a great choice if you’re in the wealth-building phase of retirement saving. Their aggressive early equity glidepath provides maximum growth potential through a low-cost, straightforward index approach. It’s a smart play to build your retirement portfolio over many years without high fees.

For 50+ Pre-Retirees and Retirees

If you’re closer to or already in retirement, the State Street Target Retirement funds are a great choice. Their well-diversified asset allocation, especially in retirement, gives you greater exposure to asset classes like small caps, real assets, and a broader mix of bonds that can enhance risk-adjusted returns and longevity.

The Choice of Target Date Index Funds is Yours

Ultimately, your choice will depend on performance, availability, costs, and your personal preferences around glidepaths and diversification. Review the details of each fund series to see what works best for your specific goals and situation.

I hope this breakdown helps you navigate the index target date fund landscape. It’s a good way to get broad market exposure and automatic rebalancing at a low cost. That being said, picking the right target date fund is about more than low costs. I believe that actively managed Target Date series can provide stronger performance, net of fees, in both good and poor financial markets, so don’t count them out. Choosing the appropriate target date fund for you is a key step towards hitting your long-term retirement goals out of the park.

MFS Lifetime Funds

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MFS Lifetime Funds – Your Defensive Approach to Retirement Savings

In my last post, I mentioned I’d be writing about a Target Date alternative that’s well-suited for those of you whose top concern is market volatility as you approach retirement. If that’s you, the MFS Lifetime Funds may be the perfect choice. They are deliberately designed to prioritize protecting your hard-earned savings as you close in on the retirement “finish line.”

The Glide Path – Designed for Your Evolving Risk Tolerance

One of the biggest advantages of the MFS Lifetime Funds is their conservative positioning in the years just before and after retirement. Their unique glide path illustrates a thoughtful transition from an aggressive, growth-oriented stance early on to a defensive, risk-minimizing approach as investors get closer to retiring. It is truly one-of-a-kind, shaped more like a hockey stick than the conventional linear equity glide paths of competitor target date funds.

Picture the MFS glide path like the race strategy for a marathon runner. Early on, the approach is aggressive – going all-out to build a solid lead. But as you get closer to the finish, the strategy shifts. Now the focus is on pacing yourself, managing your effort, and avoiding any risks that could jeopardize crossing that final line successfully after all those miles.

Broad Diversification Across Sub-Asset Classes

In addition to the defensive glide path, what stands out the most to me about the MFS Lifetime Funds is their extensive sub-asset class diversification. This diversification allows the MFS Lifetime Funds to optimize their risk and return profiles at each point along the glide path based on an investor’s specific stage in the retirement investing race. In the early accumulation phase, they can truly swing for the fences by loading up on small caps, emerging markets, and other high-upside assets. As you get closer to retirement though, the mix shifts to emphasize large cap high-quality defensive equities and investment-grade debt positions designed to prioritize capital preservation.

This conservative asset allocation mix makes the MFS Lifetime Funds an excellent choice for risk-averse investors concerned about potential market volatility derailing their nest egg in the crucial pre- and post-retirement years when they are most reliant on their accumulated savings.

A Focus on Managing Risk, Not Chasing Returns

While the glide path design and wide-ranging diversification are strong foundational elements of the MFS Lifetime Funds perhaps the most important process the management team implements comes from’ their dedication to continual active risk oversight and management, especially for conservative investors.

It’s the classic “defense wins championships” mentality. The Lifetime Funds use a similar philosophy, rigorously managing risk across all their underlying funds and the total portfolio. This emphasis on capital preservation over returns-chasing, especially as investors approach retirement, truly sets these funds apart as a trusted choice for the risk-conscious saver.

The Bottom Line

While the glide path design and extensive diversification are both valuable assets, perhaps the biggest differentiator is the intense emphasis MFS places on active risk management throughout your retirement investment journey.

Their unique glide path transitions you from an aggressive offensive approach early to a disciplined, risk-focused defensive stance when it matters most. Their robust active management ensures your exposure stays on plan and avoids unnecessary risks. And their combination of experienced leadership and a deep, diversified bench allows them to seamlessly adapt their lineup to match any market “opponent.”

So, if you’re that conservative investor worried about market storms disrupting your retirement dreams after years of diligent saving and investing, give the MFS Lifetime Funds a long look. With their unique approach, you can head into your golden years confident that your nest egg will be secure, knowing that it is being protected by a true risk-management champion every step of the way.

Next up, a few words for those of you may prefer a low cost passive index approach to Target Date retirement investing.

American Funds Target Date Retirement

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The American Funds Target Date Retirement Funds Are A Top Pick for Retirement Savings

When it comes to saving for retirement, having the right investment strategy is essential for achieving securing your financial future. It’s like having the right game plan heading into the Stanley Cup Finals. Smart decisions now pave the way for victory down the road. For my money, the American Funds Target Date Retirement Series from Capital Group is a top contender for a spot in your retirement game plan.

Like all target date funds, these funds are designed to adjust their risk level and asset allocation as you progress through different life stages. What sets them apart is their proactive approach to managing two critical risks in retirement investing: longevity risk and market volatility. Think of it as having a coaching staff that adapts your lineup and playing style to counter the opposition’s strategy at each stage of the season.

Longevity Risk – Playing the Long Game

The fear of outliving your savings looms large in retirement planning. With life expectancy on the rise, a forward-looking investment approach is essential to stretching your retirement funds further. The American Funds Target Date Retirement Series maintains a significant allocation to growth-oriented equities even as retirement approaches. This focus on growth aims to combat longevity risk head-on. In contrast, some other target date funds adopt a more conservative stance, reducing equity exposure drastically near retirement. While this may lower market risk, it increases the danger of running out of money before your time runs out.

The ’Glide Path within a Glide Path’

What sets American Funds apart is their innovative “glide path within a glide path” approach. In addition to shifting between stocks and bonds, they actively adjust the composition of equity allocations as investors near retirement. During accumulation years, the focus is on capital appreciation through growth-oriented funds. As retirement approaches, the emphasis shifts to dividend-focused “growth and income” strategies. This versatile technique balances offensive and defensive positions within the equity allocation to increase income and lower volatility. This strategy aims to address longevity risk more effectively than just shifting from stocks to bonds.

Market Risk – Defense Wins Championships

Market volatility can disrupt even the most seasoned investors. The American Funds Target Date Retirement Series addresses this by making tactical adjustments to enhance stability as retirement nears. Equity exposure shifts towards higher-income assets like dividend-paying blue-chip stocks, while fixed-income allocations prioritize capital preservation with high-quality bonds. It’s a balanced approach that capitalizes on growth opportunities while safeguarding against market downturns. It’s an approach that blends offense and defense, allowing the funds to potentially capitalize on growth opportunities when markets are favorable while also providing downside mitigation when volatility heats up.

Building Depth Through Superior Asset Allocation

A key strength of the American Funds lies in their ability to construct robust portfolios from Capital Group’s extensive lineup of mutual funds. Like assembling a championship-winning team, they have access to standout funds across various asset classes and strategies. This depth allows them to construct well-rounded portfolios loaded with quality investments at every position.

Evaluating the Track Record

Beyond the appeal of the strategy, the American Funds Target Date Retirement Series boasts a track record of performance excellence. Consistently landing in the top quartiles for performance versus peer groups, these funds have delivered superior outcomes for investors over 3, 5, and 10-year periods. And all at a cost lower than any other actively managed target date series on the market.

Is American Funds Target Date Retirement Series for You?

While your options may be limited in your employer-sponsored retirement plan, you have the freedom to choose your investments in an IRA or Roth IRA. The American Funds Target Date Retirement Series is an excellent choice for investors with a long life expectancy who are comfortable with some market risk to mitigate longevity risk. However, if market volatility is your primary concern, stay tuned for my next post, where I’ll cover an alternative that might better suit your needs.

Let’s Talk Glide Paths

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Mapping Your Journey to Retirement

When it comes to target date funds, one of the biggest decisions you’ll make is choosing the right glide path. The glide path is like a roadmap that shows how your investment mix will shift over time as you approach and enter retirement. It determines how much risk you’ll take on and what kind of returns you might see, presenting a picture of how the fund’s equity exposure changes over your lifetime.

Understanding the difference between “To” and “Through” glide paths is key. The biggest distinctions come into play in what I call the “Retirement Red Zone” – the 10 years before and after your retirement date. I illustrate with some of my favorite Target Date fund series.

The “To” Glide Path: Winding Down for Retirement

Funds like the MFS Lifetime series us a “To” glide path. These are designed to shift your asset allocation to a more conservative investment mix by swiftly reducing stock exposure by the time you reach your target retirement date. This approach aims to preserve capital and mitigate risk as you near retirement. It’s similar to a football team strategically running down the clock in the final quarter to protect their lead. The landing point – when your mix locks in – coincides with your target retirement date.

Pros:

  • Reduces risk in the ‘Retirement Red Zone’. This helps to protect your nest egg from potential market volatility and the potential of sequence of return risk.
  • A more aggressive equity allocation in the early years of the accumulation phase has the potential for higher returns when your nest egg is focused on growth.

Cons:

  • May limit returns in retirement due to a more conservative asset allocation at and after the target date.
  • The conservative equity positioning may not provide sufficient long term growth after retirement to combat inflation and longevity risk during a long retirement.

The “Through” Glide Path: Prolonging the Journey

On the flip side, a “Through” glide path extends beyond the target retirement date, recognizing that retirement is just the beginning of a new chapter. That’s like a team continuing to play aggressively even after taking the lead. Most Target Date series, including the American Funds Target Date Retirement series, use this approach and have a landing point many years after retirement.

Pros:

  • Provides continued risk management and growth potential during retirement.
  • Higher equity allocations early in your retirement years can provide the growth necessary to combat inflation and longevity risk.

Cons:

  • Potentially exposes your portfolio to higher equity risk in the ‘Retirement Red Zone” when preservation of capital may be a higher priority.
  • An aggressive equity allocation exposes your portfolio to potential large losses in a bear market late in life that could severely impact the longevity of your investments.

A Few Words About Passive Index Approach to Glide Paths

If keeping costs low is a top priority, passive index target date funds like the Schwab Target Index series or the State Street Target Retirement series offer diversified market exposure at a lower cost than active funds. While passive strategies lack don’t adjust to market conditions, they do provide consistent market tracking and broad diversification, making them suitable for many investors. However, from my perspective, it’s important to remember the adage “you get what you pay for” – active management may deliver higher net returns over the long run.

Active vs. Passive Investment Management

The age-old debate between active and passive management rages on. In my experience there are some investments where active managers can add value, while in others passive index approaches make sense. The managers running active series like American Funds Target Date Retirement series or MFS Lifetime series can dynamically adjust allocations, potentially providing higher returns but at a higher cost. Passive index series like Schwab Target Index series or the State Street Target Retirement series offer diversified market exposure at a lower cost but without the potential benefits of active management. Target Date funds are one investment area where active managers often do add value.

Choosing Your Glide Path: A Balancing Act

The ideal Glide Path for you depends on your individual circumstances, risk tolerance and retirement goals. Here are some considerations to help guide your choice:

Choose a “To” Glide Path if:

  • You are risk-averse and you want to prioritize capital preservation and stability nearing retirement.
  • You have a clear idea of your retirement income needs and have other sources of income including Social Security, pensions, or annuities.

Choose a “Through” Glide Path if:

  • You have a high risk tolerance, are comfortable with some market volatility, and expect a long retirement.
  • You prioritize growth potential alongside income generation throughout retirement.

Choosing ‘Your’ Target Date

Most of you have access to a Target Date Fund in your 401(k) or 403(b) defined contribution retirement plan. While you may not be able to choose your Glide Path in your company plan, there are a couple of tweaks you can make the personalize your experience rather than accepting the default target date closest to the year you turn 65.

First, consider your actual planned retirement age. If you plan to retire earlier or later than 65, it may be wise to choose a fund with a target date that most closely aligns with your anticipated retirement timeline. If you plan to retire at 62 or earlier select the fund with a target date 5 years earlier. On the other hand if you plan to max out Social Security and retire at age 70, then choose a fund with a target date 5 years later.

Then evaluate your risk tolerance. In a similar way to your retirement date adjustment, if you are risk-averse and would prefer a more conservative glide path than the one available to you in your retirement plan, choose a fund with a target date that is 5 years earlier than your planned retirement date. On the other hand, if you feel the glide path of the fund on your retirement plan is not aggressive enough, choose a fund with a target date that is 5 years later than your planned retirement date.

Have you got all that? After considering these factors you may decide to choose the fund that has a Target Date that is 10 years before or 10 years after you would have been assigned based on the year you will turn 65. This approach ensures that the glide path is being used in a way that is suitable for you.

Glide Paths are a Journey, Not a Destination

At the end of the day, your glide path choice should align with your investment goals, risk tolerance, and retirement income needs. It’s essential to consider factors such as your desired lifestyle in retirement, potential longevity, and the role of other income sources like Social Security and pensions.

By understanding the intricacies of “To” and “Through” glide paths, as well as the potential landing points for “Through” glide paths, you can make an informed decision that aligns with your unique circumstances and investment objectives.

Remember, a Target Date Fund is a powerful tool, but it’s just one piece of your overall retirement plan.