Can Pricey Target-Date Funds Be Competitive?
Some of these one-stop retirement offerings are way too expensive.
The mutual fund industry has long seized on trends in the market, rolling out funds to capitalize on heightened investor interest. While the tech-fund craze of 1999 and 2000 was perhaps the most egregious example, there have been others: Both emerging-markets and biotech funds first came out en masse in the early 1990s, right after those corners of the market had surged.
The latest hot fund type, however, is actually rather sedate: Target-date funds. Designed as one-stop shopping options, these funds hold a broad spectrum of stocks and bonds (typically by buying other offerings within the same fund family), and their asset allocations grow more conservative as the funds approach the target date included in their names. These funds have gained favor among 401(k) providers and wary investors in the wake of the bear market; more than two thirds of the 155 target-date funds in Morningstar's database are less than three years old, and we introduced three new fund categories in March 2006 to address this phenomenon.
Singling Out Expensive Choices
Because these funds are broadly diversified, investors are far less likely to get burned by buying a target-date fund fresh off the shelf than previously trendy offerings. That said, it's important to note that some target-date funds are significantly riskier than others--and the bolder ones tend to be more expensive. Such funds present a conundrum: While they offer the potential for higher gross returns, their loftier expense ratios will certainly cut into gains--particularly because these funds are designed to be held for decades. For example, the A shares of MFS Lifetime 2040 (MLFAX) charge 1.43%, making it one of the priciest target-date funds around. One reason: The fund has 99% of its assets invested in stock funds, which tend to charge higher fees than bond funds. (Meanwhile, the typical 2040 target-date fund has an 86% stake in equities.) It also has a 20% stake in foreign-stock funds like MFS International New Discovery (MIDAX), which are costlier than their domestic-stock counterparts. (Although the target-date fund invests in the cheaper Y shares of its siblings, the fund adds on a 0.35% 12b-1 fee that roughly matches that of the underlying funds' A shares.) It's worth noting that MFS' target-date funds turn conservative at a more-rapid rate than many of their rivals, so MFS Lifetime 2010 (MFSAX) is far cheaper than the 2040 option. The 2010 option's price tag, at 1.09%, is lower than the front-load norm for the category, but it still strikes us as high for a fund with just 37% of its assets in equities.
Greg Carlson does not own (actual or beneficial) shares in any of the securities mentioned above. Find out about Morningstar’s editorial policies.