Off Target: On the Underperformance of Target-Date Funds

55 Pages Posted: 23 Nov 2020

See all articles by David C. Brown

David C. Brown

University of Arizona - Department of Finance

Shaun Davies

University of Colorado at Boulder - Leeds School of Business

Date Written: October 8, 2020

Abstract

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

Brown, David C. and Davies, Shaun, Off Target: On the Underperformance of Target-Date Funds (October 8, 2020). Available at SSRN: https://ssrn.com/abstract=3707755 or http://dx.doi.org/10.2139/ssrn.3707755

David C. Brown

University of Arizona - Department of Finance ( email )

McClelland Hall
P.O. Box 210108
Tucson, AZ 85721-0108
United States
520-626-0746 (Phone)

HOME PAGE: http://www.davidclaytonbrown.com

Shaun Davies (Contact Author)

University of Colorado at Boulder - Leeds School of Business ( email )

Boulder, CO 80309-0419
United States

Do you have a job opening that you would like to promote on SSRN?

Paper statistics

Downloads
709
Abstract Views
2,174
rank
43,375
PlumX Metrics