Target-dated retirement mutual funds are getting more and more popular, offering instant diversification into stocks and bonds, as well as automatically shift to a more conservative blend as you near your target retirement date. An all in one fund! Whenever you see a finance article talk about the “best” of these mutual funds, invariably Vanguard and T. Rowe Price top the list. Recently, Kiplinger’s Personal Finance magazine named T. Rowe Price “the best Target fund available”. I’ve been meaning to do my own personal (and imperfect) comparison for a while now.
What makes a fund good?
First, why am I picking these two to compare? If you’ve read the books on my reading list, you’ll know that history and research has shown that the two most important factors that predict long-term performance are:
- Asset class – What is the fund invested in? Large-cap domestic stocks? Short-term bonds?
- Expense ratio – How much is the mutual fund company charging for its services?
Vanguard founder John Bogle sums it up well:
“Asset allocation is critically important; but cost is critically important, too. — All other factors pale into insignificance.”
Let’s quickly compare five of the bigger Target fund families, taking the 2045 date as a sample. Listed are the percentage of domestic stocks, international stocks, expense ratios, and year-to-date performances.
|Symbol||US Stocks||Int’l Stocks||Expense Ratio||YTD Return|
|T. Rowe Price 2045||TRRKX||70%||20%||0.76%||13.93%|
|American Century LiveStrong 2045||AROIX||66%||18%||0.94%||12.93%|
It is clear all the companies agree with the first factor at least, as the asset allocations are very similar across all five funds.
As for the second factor, expenses, Vanguard is the winner by a wide margin. Schwab and American Century seem to be very careful not to break the 1.0% expense barrier, while T. Rowe Price and Fidelity are at a respectable 0.76% considering they consist of mostly actively managed funds. (I am ignoring small balance fees, to be addressed later.)
Note that past performance is not listed as a critical factor. 1-Year, 3-Year, and 5-Year performances for specific funds are not a reliable indicator of long-term performance. I’ve only listed them to show that they are more-or-less similar. For now, it seems Vanguard is above average in the performance area.
I am taking T. Rowe Price (TRP) the edge over Fidelity because Fidelity’s Freedom Funds seem to be a hodgepodge of overlapping funds (22 separate funds, with as little as a 0.10% contribution), while TRP seems to have a slightly more clear asset allocation goal (13 funds). Also, T. Rowe Price allows lower entry requirements for investment.
T. Rowe Price (TRP) vs. Vanguard (VG)
Okay, now let’s get to the the head-to-head comparison of their entire Target Retirement fund families.
Here is a chart showing the percentage of stocks in the funds, depending on the target date.
It is quite clear that the T. Rowe Price funds are more aggressive, and hold more stocks even very close to retirement. This is also the primary reason why you may hear that TRP funds have outperformed Vanguard funds. Stocks have done well recently.
This is fine, if that’s what you want. But you can also get a very similar effect if you simply shift the Target date of the Vanguard fund forward by five years. See the comparison now:
Much, much closer. So if for example you want something that will start and adjust over time closely to the TRP 2030 fund, just go for the VG 2035 fund.
Hmm… but maybe the TRP funds have more of a value or small-cap tilt, due to their use of more asset-class funds? (Small and value stocks have historically outperformed large-cap and growth stocks.) Let’s use the Morningstar X-ray tool and see. Again, we’ll just compare just the 2045 flavor to save time.
Although not conclusive, it’s interesting to note that not only are (1) the style boxes are very similar, but (2) the one with more of a value tilt is Vanguard’s fund, not T. Rowe Price.
Expenses and More
Both of these funds are no-load and have no commission if you open an account directly through the respective companies. Now, since the asset allocation was pretty much a draw, you’d probably expect me to say Vanguard is the winner hands down. Not quite.
Vanguard requires $3,000 to invest in any of its Target funds. In addition, it charges IRA accounts a fee of $10 a year for each fund account with a balance of less than $5,000 (waived with high overall balances). $10 a year on a $3,000 balance is another 0.33% of expenses. Still, on the 2045 funds this makes the total 0.53%, which remains lower than TRP’s 0.76%.
This reflects Vanguard’s unwritten philosophy that account holders should pay for their own costs. That is, small accounts still have the costs of IRS reporting, mailing statements, etc. Remember, .20% of $3,000 is only $6 a year. Having low-balance fees keeps costs down for larger investors. As you’ll hopefully only spend a limited time being a “small” investor, this will probably work out best in the long run.
T. Rowe Price, on the other hand, only requires a $1,000 initial investment for IRAs, and $2,500 for a taxable account. They also charge a low-balance fee of $10 a year for balances less than $5,000 (also waived with high overall balances). But, if you can commit to an automatic transfer of $50 a month from your checking account, you can open an account with nothing. Not even low-balance fees. This is a great proposition for beginning investors. I’m sure T. Rowe Price believes that this program will help create a loyal customer for the future. Of course, the cost of doing this also gets rolled into the higher expense ratio somehow.
Although I personally don’t invest in a Target fund anymore (I used to) because I feel that the potential performance gain from specifying my own asset allocation and maximizing the tax-efficient placement of my funds is worth the additional effort, I still think these are a great invention for the average busy person who needs to think about retirement.
(That said, once you get some decent balances it’s really not that much more work. I haven’t touched my portfolio in months.)
I think I have shown these two funds to be very similar. In the end, I think for a long-term investor I would still prefer the Vanguard series due to the lower expense ratio. But if you went T. Rowe Price for the low starting requirements, you’d still be making a decent choice.
Just please don’t buy an overpriced Target fund. I think American Century’s use of the LiveStrong brand is a stupid marketing gimmick. What does Lance Armstrong have to do with my retirement? I like my charity separate, thank you.