Managing a retirement portfolio is like being an airline pilot. You're striving for a smooth ride and a safe landing in turbulent conditions. It involves changing your asset mix over time, which can be a complex and time-consuming task.
One low-maintenance solution is a target-date fund. These are portfolio funds that start out emphasizing growth-oriented investments, and become more conservative as their maturity date nears. They're designed to accommodate investors' changing objectives and risk tolerance over various life stages.
Target-date funds are best suited for investors who don't want to keep rebalancing their investments on their own, says Robert Armstrong, vice-president and head of managed solutions at BMO Asset Management Inc. "These funds can act as a core solution in a portfolio but provide the option for investors to add other fixed-income or equity options on the side for increased diversity."
Target-date funds started to appear in Canada in 2004 and have since grown to be a $6-billion market. There are currently eight fund families that collectively offer 60 distinct funds, not including multiple versions of the same fund. The largest player is Fidelity Investments with $2.3 billion in assets, followed by BMO with $1.1 billion and Dynamic Funds with $497 million.
Target-date mutual funds fall into four categories on the basis of their maturity dates: 2015 or earlier; 2020 or earlier and after 2015; 2025 or earlier and after 2020; and after 2025.
Although primarily serving investors who are saving for retirement, target-date funds can also be tapped into to meet other investment needs. "The funds can also serve as a savings vehicle for large purchases," says Armstrong, "and for those who have education-focused goals such as saving for a child's post-secondary education."
Further, target-date funds can provide tax-efficient post-retirement income. "Some programs incorporate a payout schedule that is predominantly made up of return of capital," says a spokesman for Invesco Canada Ltd., which sponsors the Invesco Intactive target-date portfolios. "As such, if someone is approaching retirement and looking for income to bridge the gap, they can use these tax-efficient distributions."
Investors must consider a range of factors when selecting the right fund for them. Though target-date portfolios across different providers have similar maturity dates, investors need to look under the hood to understand the differences between products.
The main features to focus on are the portfolio's asset mix and the shape of the glide path, a formula for determining asset allocation at various stages of the fund's life.
In addition to selecting a fund that is in line with your investment horizon, it's important to consider whether the asset mix aligns with your risk tolerance. Funds can have very different risk profiles, even if they're in the same target-date category.
For example, one portfolio may have an asset mix of 60% equities and 40% bonds, while another with the same maturity date can have a 35% equity and 65% bond allocation.
"Many programs offer different asset allocations at maturity," says the Invesco spokesman. "Some programs start with a more aggressive asset mix and end with what is considered to be a balanced allocation of stocks and bonds. Others glide down to pure money-market exposure at maturity."
Hence, investors should take into account the time frame after maturity during which they plan to redeem the funds. For a shorter time frame before cashing in, a more conservative approach may be preferred.
Target-date investors also need to consider the quality of the underlying funds and their portfolio managers. Most fund companies tend to invest in their own funds, though others rely on third-party managers. Depending on the fund, a combination of active and passive investment styles may be employed.
Also relevant in evaluating target-date funds is the experience and commitment of the fund sponsor to this asset class. A number of providers have entered the target-date arena, only to abandon it a few years later.
"Many start saving for retirement in their early twenties and contribute for 40 years before starting to withdraw money in retirement," says Craig Strachan, vice-president, product research, at Fidelity Investments Canada. "It's important to select a provider that has extensive experience managing target-date funds."
Management fees and expenses are another important consideration, since they cut into returns. Median management-expense ratios (MERs) range from 1.05% for funds in the 2015 Target Date Portfolio category to 2.28% in the 2025+ category. Note that management fees will be lowered in stages as the portfolios approach maturity and their asset mixes shift more toward fixed income.
MERs can vary significantly among funds with similar target dates, largely because of different distribution models. Your best choice will depend on how much you value the services of an advisor.
For instance, IA Clarington Target Click 2025 has an MER of 2.54% and DynamicEdge 2025 Portfolio Series A charges 2.44%. Both of these advisor-sold funds cost considerably more than PH&N 2025 LifeTime Series D, a direct-sales fund whose MER is more than a full percentage point lower at 1.33%.
The amount that you have to invest will also affect your choices, and how much you'll pay in fees. For example you can buy into Fidelity ClearPath 2020 Portfolio Series A for as little as $500, but will need to fork out a minimum of $10,000 to buy into BMO LifeStage 2020 Class Series H, and a whopping $100,000 for Invesco Intactive 2023 Portfolio P. However, investors in higher-minimum funds pay reduced fees, essentially getting a volume discount from the more affordable series.
Risk-averse investors may want to consider products with a built-in guarantee to protect capital. Although they're becoming scarce, some target-date funds offer a guaranteed payout if held to maturity. Typically, this amount is either the highest daily or the highest month-end net asset value of the fund.
The peace-of-mind value of these funds is open to debate. Investors who lock in the minimum-floor guarantee to target date also tend to lose out on significant growth opportunities presented by market rallies.
Target-date funds with guarantees, depending upon how they were structured, surprised and disappointed many investors in the 2008-09 period, Strachan asserts.
"When the equity market collapsed, the event triggered portfolio allocations to 100% fixed-income investments, typically T-bill strips, with maturities tied to the guarantee horizons," he says. "The result was that when markets sharply rebounded beginning in March 2009, these funds could not participate in any of the market recovery and subsequent strong growth."
The guaranteed funds currently available include the IA Clarington Target Click funds, each of which guarantees to pay out, at maturity, the highest month-end price it ever reached. Funds in the BMO LifeStage series have a somewhat stronger provision, guaranteeing the highest daily net asset value of the fund.
The cost of providing guarantees results in higher fees compared to those of non-guaranteed funds. Not coincidentally, the target-date fund with the highest MER is IA Clarington Target Click 2030 Series A, which charges 2.84%.
