Off Target: On the Underperformance of Target-Date Funds
55 Pages Posted: 23 Nov 2020
Date Written: October 8, 2020
Target-date funds (TDFs) are popular vehicles that provide investors with an evolving asset allocation to meet their needs at some future date (e.g., retirement). While TDFs provide investors with extensive diversification and active rebalancing, TDFs are also a type of fund-of-funds. As such, investors pay multiple layers of fees as most TDFs charge fund-of-funds' fees and also hold funds that collect additional fees. We show that TDFs are easy to emulate with a portfolio of cost-efficient exchange-traded funds (ETFs) and we coin these portfolios Replicating Funds (RFs). RFs substantially outperform TDFs, exhibit low tracking error, do not suffer from cash drag, and require infrequent rebalancing. Our analysis shows that TDF sponsors collectively charged nearly $2.5 billion in excess fees in 2017 alone. We provide a normative rule-of-thumb for investors to construct their own RFs using low-cost ETFs.
Keywords: Target-Date Fund, Exchange-Traded Fund, Financial Planning
JEL Classification: G10, G11, G23, G50, G51, G53
Suggested Citation: Suggested Citation