Target Date Retirement Funds: Beating The Behavior Gap

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The general consensus behind target-date retirement funds is often “They’re okay… but here’s something better!”. Any all-in-one product will be imperfect. But I still like them on the whole and have written previously about how Vanguard’s target-date retirement funds are underrated. If you’re invested in them, this Bloomberg article and Morningstar data should make you feel even better about it.

Most mutual fund investors actually do worse than market returns due to poor behavior, termed the “behavior gap“:

But target-date funds have one big advantage over other kinds of mutual funds, the data show. The average mutual fund has a flaw, which is that the average investor hardly ever does as well as his or her funds. Investors tend to jump in and out of funds at the wrong time. They buy high, choosing funds only after they’ve done well. And they sell low, dumping underperforming funds just as they’re about to take off.

However, owners of target-date fund actually did better:


On average, target-date fund investors are doing 1.1 percent better per year than their funds. Investors in almost every other fund category lagged their funds over the past decade, including a -0.98 percent underperformance for U.S. equity funds and -1.3 percent for municipal bond funds.

The outperformance may be a temporary anomaly, but I do think there are unique features of these all-in-one funds (and their investors) that will persist:

  1. Self-selection. If you buy a target-date fund, you desire simplicity. You have a degree of humility. You don’t overestimate your skills as an investor, otherwise you’d buy something else.
  2. Optical illusions. If you own an all-in-one fund that holds both stocks and bonds together, you don’t have the problem of seeing one investment drop while the other rises. It’s all mixed together in one pot, so the impact is usually dulled. This is the benefit of buying a “balanced” fund.
  3. Automatic rebalancing. Anything that makes you look at your investments is an opportunity to make an emotionally-driven choice. Since these funds even rebalance their holdings for you automatically, you’re not even required to rebalance, which can be hard to do. Right now, a portfolio would probably have to sell stocks and buy some bonds while the media keeps talking about rising rates.
  4. Tweaking is difficult. If you have one stock fund and one bond fund, it’s very easy to buy little more of one or a little less of the other. With an all-in-one fund, it’s harder to tweak your mix.

So you don’t have to do anything, and if you want to do something besides just buy more, it’s a pain. All this means less trading, which over the long run is a good thing.

So don’t be ashamed of buying a diversified, low-cost Target Date fund like Vanguard 20XX or Fidelity Freedom *Index* 20XX funds. The article ends with a good reminder that costs still matter. Don’t overpay for one of these funds either, and maybe even raise a little stink if you are being asked to.

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  1. So I’m sort of confused on the comment “On average, target-date fund investors are doing 1.1 percent better per year than their funds. ”

    I understand how “regular” mutual fund investors can do worse by jumping in and out. However how can you truly do better than a fund (as in the target date funds), other then getting the jumping in and out timing correct?

  2. I so bad want to jump on the Vanguard band wagon, but it seems like my T Rowe Price retirement 2040 & 2045 funds do a tad bit better than Vanguard Target Retirement even with the higher expense ration (.76% vs .18%). Do you have any opinion on T Rowe Price?

    • The following is all my opinion… TRP target funds are fine. I would be okay holding them if it was my only choice inside a 401k. TRP has relatively low costs for an actively-managed fund, and historically they are decent if not good managers. I get the feeling they would be acceptable stewards of my money, which I can’t say about many other companies out there. TRP and Vanguard have different asset allocation and glide paths, so it can be hard to tell if higher performance is due to a different asset allocation or active management.

  3. @ TJ, the grass always seems greener somewhere else. IMO, you should stick to a great company and let them do their thing. TRP is a great company and they have served their clients incredibly well…and at very reasonable costs/fees. Don’t keep looking over your shoulder, just enjoy what you have…and enjoy the ride. You have your whole life to second guess your choices. Sometimes you just have to know when great is good enough.

  4. My only beef with the target date funds is that, as highlighted in the comments to your earlier posts on Vanguard’s — it starts with a relatively high bond percentage for young investors. Maybe it is part my risk appetite, but I believe one should largely be holding stocks for the first 10 years or so in one’s retirement accounts.

    • Vanguard starts out a 10% bonds / 90% stocks and stays there for a while. I personally don’t think 10% bonds is very high at all. I think I had some data regarding risk/reward ratio but don’t remember off the top of my head.

  5. I understand how the +1.1% is possible, but it makes me wonder about the magnitude of noise in their data. Seems like the differences between funds may well be meaningless.

  6. Well this boosts my confidence a little bit. I am invested into the Vanguard 2060 target retirement fund and I’ve been happy with it. I have been wanting to reach out of it though and buy into another Vanguard fund. Currently the target fund is the only Vanguard fund I have so I want to put some money into something that’s different enough from it, if that makes sense. Any recommendations?

  7. Target Retirement funds are meant to be all-encompassing, IK, so if you add another fund you will likely be doing more harm than good. You basically already now own the entire US Market, the entire International Market (including Emerging Markets), the entire US Bond Market, and now even International Bond Markets. What else are you wanting?

    • Jack, I guess I am wanting to be more invested in a specific industry (e.g. tech or healthcare).

      • I think sector bets are okay, especially if one is perfectly willing to be wrong about the timing of such investments. But I think the little guys are merely pawns (if that) in the investment world. The markets are often manipulated by many of the big players and we are at their mercy.

        That said, if I had to make a sector bet right now I might look at Energy. It seems to have bottomed out…maybe). Best of luck to you IK.

  8. Do you have any recommendations for how to ‘beat the behavior gap’ in a taxable account? I want simple and diversified index funds, but the bond portion of target date funds might not be tax efficient in a taxable account.

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