Think about all the elements you need to be a successful index investor. First, you need to choose the right mix of stocks and bonds, and to adjust that mix as you approach retirement. Your portfolio needs to be broadly diversified and low-cost. You need to save part of your paycheque in a disciplined way, rebalancing your portfolio from time to time, and resist distractions so you won’t be tempted to abandon your plan.
If you have a defined contribution pension plan or group RRSP through your employer, there may be a simple solution: the target date fund. These products were created in the 1990s for workplace investment plans in the US, and they’re now widespread in Canada, with BlackRock’s LifePath and Fidelity’s ClearPath family the most common. These incumbents will now face a challenge from Vanguard, who manages over $358 billion USD in target date funds in the US and recently announced its own series of Target Retirement Funds in Canada.
The idea behind target date funds is brilliantly simple: each one is a balanced portfolio of bonds and global equities in various proportions, from aggressive to conservative. You pick the one with the target date closest to the year you plan to retire: for example, if you plan to retire in 20 years or so, you’d choose a fund with a target date of 2035. Today that fund might be 25% or 30% fixed income, but here’s the hook: the fund will follow a “glide path,” gradually getting more conservative as you approach retirement. By the time the target date is reached, the fund will be primarily in bonds and T-bills.
Many in the financial media like to rip on target date funds, calling them cookie-cutter solutions that don’t account for each investor’s individual needs. But while these funds are not be customizable, they can be an still excellent choice if you’re looking for a workplace plan to complement your self-directed indexed portfolio.
The tyranny of choice
Target date funds were created as a way of helping people with the often overwhelming decisions about how to invest their retirement savings. Researchers have long known that the more funds employees are offered in their workplace plans, the less likely they are to contribute because of analysis paralysis.
Opting out of your company’s plan is usually a huge mistake: if you have the opportunity to make automatic contributions that are topped up by your employer, you should be doing it. Yet it seems that Canadians are leaving about half that money on the table. Target date funds solve the problem of analysis paralysis by simply asking investors to pick a single fund that corresponds to their retirement date.
Target date funds—like traditional balanced mutual funds—also encourage investors to focus on their total return, not on the performance of individual asset classes. When you build a portfolio of multiple funds, it’s easy to be distracted when Canadian equities are up but emerging markets are down, or bonds are flagging while US equities are soaring. Investors can lose sight of the fact that diversified portfolios are supposed to work that way.
Some commentators—usually advisors who favour active strategies—even criticize target date funds for not allowing a manager to adjust the asset mix in response to market conditions. But as any Couch Potato knows, that’s precisely why they’re so valuable. The evidence is overwhelming that paying someone to make tactical shifts in your asset mix is likely to subtract value, not enhance your long-term returns.
Staying on target
Despite their appeal, however, there are a few things to watch for if you’re considering using a target date fund in your workplace plan:
Watch the risk level. The right asset allocation for you depends on more than just your planned retirement date. Two investors planning to quit work in 2025 don’t necessarily have the same comfort level with the ups and downs of the market.
Indeed, many target date funds seem overly aggressive to me. Vanguard’s new lineup, for example, sets its equity allocation at about 90% for anyone looking to retire later than 2040, which could include people now in their 40s. Very few investors are comfortable with an equity allocation that high.
If you’re a conservative investor, consider choosing a fund with an earlier target date if you would prefer less volatility.
Don’t assume they’re all the same. Target date funds from different providers can have quite different strategies. Consider the Fidelity ClearPath® 2035 Portfolio and the BlackRock LifePath 2035 Index Fund: while both hold roughly the same overall mix of equities and fixed income, the Fidelity fund has more than 37% in Canadian stocks while the BlackRock version includes only 20%.
Fidelity’s ClearPath offerings are also built from active funds, while BlackRock (who is the parent company of iShares ETFs) uses underlying index funds. Vanguard’s new Target Retirement Funds will also be built from a new family of pooled index funds designed for large institutions.
Be aware of costs. Target date funds are offered with the range of management fees: the primary factor is how much of the cost your employer is willing to bear. If you work for a big company with excellent benefits, the cost may be just a few basis points, but I’ve seen employees of small firms paying close to 2%. If the price tag is too high they only make sense if the company match is generous—and even then you should probably transfer the funds to a self-directed RRSP as soon as you’re eligible.
Are target date funds the optimal investment product? No, but they shouldn’t be compared to perfection. They should be compared against the most common alternatives: building poorly diversified portfolios of random funds, or even opting out of retirement plans altogether. Against that backdrop, a cookie-cutter solution looks pretty good to me.
Is there anything similar that individuals can access?
@William: No, unfortunately these funds are only available through group plans. In theory the providers could make them available through advisors, but advisors tend not to use balanced funds because they are concerned the client will think they’re paying for “nothing.”
I chose a target date fund for my employer-offered pension plan for all of the reasons listed in this piece. Another reason is because my funds are managed with Sun Life Financial and their online portal is really difficult to use. Even if I wanted to manually diversify and manage my funds, it would have been terribly frustrating to do so because of their clunky online tools.
Got to keep things simple in my opinion. there are so many products out there and with the sellers sweet talking all the pros of the product it’s getting more and more difficult to choose and when people do choose and see the product do poorly for a period of time they end up giving up for awhile or switching to something else. The biggest problem for the ordinary person is the people and outfits selling the investments. I find it odd to see a lot of money market funds lately reducing their fees in order to keep the returns positive in this era of low interest rates, it’s clear they have been taking advantage of the little guy for years and years
And to see companies such as valeant go up to $350 share and now down to $40, the normal person can’t understand the system, how one day valeant is worth more than royal bank and 6 months later is work just a fraction, it’s not the first time for a company to do this.
Then they wonder why so many people keep money in cash as it loses to inflation etc, well cash is king, $35k invested in 100 shares of valeant 6 months ago would be worth $4k today and likely will not see back to even in a very long time if not ever.
One thing that should be required by law is for the salespeople of the investment companies having to disclose what their personal investments are, not what value they are but just what the investments are. I would bet the majority portfolios would look way different than what they suggset to clients to have who have the same investment horizon and needs. That would show how corrupt the industry truely is. Watch market calls past picks on BNN of their guests, what a joke, experts picking stocks that have gone down 80% in a year, experts don’t fail, they’re aren’t experts.
And that is why I’m such a fan of the basic index investing. and the unattractive gic’s !!!
Thanks for the post. I found your comment “I’ve seen employees of small firms paying close to 2%” quite interesting as this is something I’ve seen myself.
I work at a large global tech firm that offers its Canadian employees, through through SunLife, a blessedly small selection of Blackrock funds, mostly index. The managements fees we pay for index funds mostly fall in the 0.35-0.8% range. In fact I implement an equivalent of your TD e-series portfolio slightly cheaper than through TD.
My girlfriend on the other hand just started working at a medium-sized NGO with offices in Canada and they’re offering their employees a bafflingly huge selection of funds (I’d say about 40 funds), and implementing a similar portfolio through her work is about 1.4% higher (i.e. it would cost me about 0.3% MER, and her about 1.7% MER). Over the years that’s a huge drag!
@William @CCP Maybe I’m misunderstanding what William was asking or how Dan was responding, but I just logged onto my TD Direct Investing “WebBroker,” checked the mutual fund screener and found a variety of options for Target Date Portfolios, including Fidelity ClearPath. These are all for individuals.
@Russ: I know the Vanguard funds will not be available to retail investors; I am not sure whether the BlackRock and Fidelity versions are. Keep in mind that just because a fund appears in the screener on your brokerage does not mean you will actually be able to purchase it. For example, the TD e-Series show up in the lists at other brokerages, but you can only buy them through TD Direct.
@CCP Dan, no doubt you are correct on that point, although I think TD does a pretty good job (depending on your point of view) in their fund filtering of not listing mutual funds that they won’t allow you to buy through their services. For example, TD used to allow the purchase of Steadyhand funds (at a rather egregious 2% fee) but that’s no longer possible so their funds no longer appear in the screener nor anywhere in TDDI’s research area. If William was asking for something similar to those that you mentioned but not necessarily from Vanguard or BlackRock, he may be able to find retail solutions from a variety of fund providers.
I would also point out that they’re tax-inefficient, since you need to have the same allocation across all accounts. So even if they come out with a target-date fund with individuals, going with Wealthsimple (where they can customize your asset location) would be better, in spite of the higher fees.
@Matt: Let’s remember the context here: target-date funds are designed only for tax-sheltered workplace plans, so using a robo-advisor with multiple accounts is not really a comparable alternative. I am also not aware of robo-advisors offering custom asset location strategies. Do you have any specific information on how they do this?
My employer offers the BlackRock LifePath funds in both our DC and Group RRSP plans. Costs are quite low. In the DC plan, management fees range between 0.25-0.26%. In the Group RRSP, the company does not absorb any extra costs and the management fees are 0.44-0.46%.
Both plans also offer active and index funds in all the usual categories with fees ranging from 0.14-0.91%.
I used to select my own combination of the index funds but switched to LifePath a number of years ago.
First I should say thank you Dan, when I found your blog last November and began to educate myself on indexing it quickly became clear this was the best strategy for me both mathematically and psychologically. I dumped all my idle RRSPs into the RBC index funds in January as each of my GICs matured. Didn’t time the market, just divided by four and sat on my hands. Following the financial news has only helped sell me on indexing – In January Bill Ackman said buy Valient and the Royal Bank of Scotland said dump equities government bonds are where its at. I would be kicking myself if i followed the herd. Broad diversification and low cost are good for your mind and your wallet.
This was an excellent post, i was actually just thinking about this recently. I am lucky enough to have a very generous (5%+10%) DC plan with a large multinational. My target date is about 2055 as I am 25 right now. I’m currently in a target date fund.
I can use a target date fund filled with Mawer, Templeton and Buetel Goodman funds .The target date fund fee is 0.525%. These funds all seem to have a long term approach and a value tilt from what I can see. There is also an international bond component to these funds. If I was to get these funds outside the DC plan the fees would be much higher for me.
My 4 fund index alternative in the plan follows the regular EAFE index, Dex Bond, S&P 500 and TSX 240. The weighted average fee for me for a similar asset allocation (75%eq-25%fi) would be .325%. I would have to rebalance this myself.
I will keep indexing my personal accounts and stay in the target dates for my DC plan. I think the convenience of the target date fund and the slightly broader diversification (emerging markets, small cap and foreign bonds) make it worth the extra 0.2%.
I guess we will see in 40 years which strategy worked the best, pure passive indexing or low cost value active.
“I work at a large global tech firm that offers its Canadian employees, through through SunLife, a blessedly small selection of Blackrock funds, mostly index. The managements fees we pay for index funds mostly fall in the 0.35-0.8% range. In fact I implement an equivalent of your TD e-series portfolio slightly cheaper than through TD. ”
I read your post regarding the SunLife blackrock index funds with great interest. My employer’s DCPP & RRSP plans are also managed through Sunlife, however the funds available to employees do not include Blackrock index funds and the MER’s are substantially higher, typically in the 1 – 1.5% range.
Obviously SunLife tailors the fund offerings per company. Would you be able to list off the various SunLife Blackrock index funds that you have available as investment options? I would like to inquire with our SunLife administrator to find out why we also don’t have access?
@CCP: My mother uses Wealthsimple. They assign you an advisor (a human advisor), and you can call them up and they’ll customize a tax-efficient asset location plan for you.
@CCP: for retail investors, does it make sense to mimic (or at least learn from) the asset allocations of target date funds? For example, most target date funds for someone my age (early 30s) have a 90/10 equity-fixed income mix, which would be classified (under your model portfolios) as “aggressive”. If I use target date funds as asset allocation benchmarks (and ensure I’m rebalanced accordingly every five years or so) would this be a feasible strategy? Thanks.
@Jonathan: I would not follow these asset allocations too closely. As I mention in the blog post, a 90% allocation is very aggressive and would not be my default for anyone. You should only go that aggressive if you are an experienced investor who has endured a bear market before without abandoning the plan.
I’m also not convinced that investors need to change their asset allocation according to a fixed glide path, i.e. increase fixed income by 5% every five years. A lot depends in individual circumstances, so this decision should be done more thoughtfully.
My issue with Target Date funds is their glide path. I worked for a major FI and we offered some of these funds that happened to change asset allocation to a more conservative portfolio in 2009. It’s important to know how the funds expect to re-balance and over what time frame. If it’s only small adjustments every year, you aren’t likely to take a bath. But from what I have seen, there is always the risk that the fund will change allocation right after a market downturn, it took much longer then it should have to make up for the losses. It was selling low and buying high, just what you shouldn’t do! If someone were to just go with a more balanced approach from the start, they don’t really have to make adjustments until they retire and won’t sacrifice significant upside doing it.
Can confirm. Fidelity Clearpath funds are accessible to individuals. I’ve been buying Fidelity Clearpath (Series B) units through my RBC Direct Investing account since 2006. Some series of the funds are not available, but Series B and A certainly are.
I think target-date funds are an excellent tool for RSP plans. It’s the ultimate in auto-pilot investing and anyone can do it.
@Brad: I think one needs to check the fees on these funds. The Fidelity ClearPath Series A and B options can charge as much as 2.5%, and of course they are all actively managed. I appreciate that they are convenient, but that is too a high a price for convenience. Even a simple option like the Tangerine funds cuts that fee by more than half.
When I presented these as a good option in the article, I was assuming that most people using them would not be inclined to use a self-directed option like a discount brokerage, that there was some kind of employer match, and that the fees were low because the employer covered at least part of the cost.
Great Post Dan,
I think these are a fantastic option for people who have all of their investments in registered accounts. I didn’t see anywhere in your post anything about this topic but it is a significant one for higher net worth investors. Using these target funds or balanced funds can make your overall portfolio much less tax efficient because you can’t manage your asset location.
But the vast majority of individuals have all their savings in registered accounts so I think that these target funds are great for the majority. I believe the simplicity of them promote people to do nothing but auto contribute monthly and reduce the temptation to tweak. It seems that the benefit of less drag due to fewer mistakes would likely outweigh any inefficiency of the fund (as long as they are low , below 0.5% or so).
@CPP and Matt
I see now you already started to discuss the topic of tax sheltered accounts. I just checked and see that the target date funds are only available in the DCPP for both my plan through Sunlife and my wife’s through Standard Life. They are not available for the RRAP, TFSA, or no registered accounts through those same providers.
But my point is still the same for higher net worth individuals you have these group plans. My approach has been to put 100% in a bond index in my DCPP accounts. This is only makes up about half of my bond allocation for the total portfolio. This way I don’t have to waste registered room on Canadian Equities and to allow for more room for doing all my rebalancing in RRSP accounts.
I have BlackRock’s LifePath through SunLife DCPP. The fee are quite high IMHO, like 10$ worth of share a month, but it’s the price to pay to get my employer 5% match…
Dan wrote: “When I presented these as a good option in the article, I was assuming that most people using them would not be inclined to use a self-directed option like a discount brokerage, that there was some kind of employer match, and that the fees were low because the employer covered at least part of the cost.”
I think that what is driving the interest in a retail option, though, is the simplicity which easily allows for DIY investing, and the fact that increasing numbers of people are without any sort of employer-sponsored retirement plan. I see that RBC’s Phillips Hager & North group of mutual funds even has a D-series (lower than standard MERs, intended for DIY investors) range of “LifeTime” funds. A spot check of MERs showed a range of 0.90% to 1.31%.
Just so you know, I don’t work for RBC. I just used my discount brokerage filter to look for low MER target date funds and PH&N was at the top of the list. MERs are not the only factor, of course, but as Morningstar research has indicated, expenses are a significant determinant of performance.
This is unrelated to this specific blog post, but I do find it funny that the ads on this page (from Vanguard) are trying to entice us to click with the following proclamation:
“Financial advisors can add about 3% in net returns through seven dimensions of advice”
Better than the “Punch a monkey to win an iPod” of old, but “wrong audience” comes to mind :)
(PS: I disable my Adblock for this site to support Dan – I suggest everyone follow suit. I know it probably doesn’t amount to much cash but this site has been invaluable to me)
Another good post. Always good content from the Couch Potato!
It’s interesting that you say that these glide paths are often overly aggressive. At my employer, I didn’t find my glide path to be aggressive enough so I selected a retirement date that is actually later than my intended retirement date.
Keep up the good writing!
Wondering if a potential “hack” with my group plan (currently in a 2055 fund) is that every time a new target date fund comes up, say the 2060, keep what I have in the previous ones, and all new contributions go to the newest target date fund. This way, it still gets conservative over time, just not too conservative.
By the time I retire, I’d have different pools in 2055, 2060, 2065, etc., of different sizes, and let the allocation percentages grow organically?
@Gaby: Any combination of target date funds must have an overall asset allocation. So why not simply select the one fund that is closest to that allocation?
I guess my main concern is that it gets a bit too conservative for my tastes closer to retirement. I may be overcomplicating things. Better to just transfer to a new fund every 5 years if I want to maintain a more aggressive allocation. Thanks for the response.
Hi all, I’m new to this world of investing, and my company just got a RRSP program with Manulife.
How do we know which of those options are 100% index funds (or are they?)
We got the choice to use one of those Fidelity program or build our own portfolio. However, it’s not clear if all those funds are index funds, etfs, or mutual funds
Hi, all. I signed up for a group RRSP with RBC through my employer. They aren’t matching any funds, but money is automatically deposited pre-tax into the RRSP. Because I am in the group RRSP apparently I can’t participate in any self-directed investing with RBC. That being said, they are suggesting the target date fund RBF1514 2045 retirement portfolio. I’m very new to any of this, but I am considering the target date fund because it seems an easy option, and the automatic contributions pre-tax are already set up. RBF1514 has a MER of 2.01 and 1.7 management fee. I see the primary benefit of sticking with RBC being the pre-tax contribution automatically coming off my pay cheque. Would I potentially be in a better spot finding another RRSP and not paying potentially high fees with RBC, or does the current set up put me in a good position going forward? Thanks!
@Adam: I think this depends on how likely you would be to maintain a similar RRSP strategy on your own. With a 2% MER and no employer match, your group RRSP isn’t offering you anything except convenience. If you’re able to set up a self-directed RRSP and make regular contributions (you can automate these) you’re likely to be better off in the long-run. You won’t be able to make pre-tax contributions, but of course you’ll get a refund when you file your return.
Could one use Target Date Funds as a guide to purchase the right mix of ETFs and help with the rebalancing process each year? By looking at the components of the fund, could one purchase those individual components with any fund company they prefer and at the same percentage distribution inside that Target Date Fund? And rebalance by looking at the breakdown of the fund each year?
Is there a Target Date Fund available in Canada that has index funds within its structure.
@Dr. Pat: There are Canadian target date funds that use underlying index funds, but I don’t think it would be useful to use these as a guide for assembling your own portfolio. It’s not necessary to adjust your asset allocation every year, or even every four or five years. Using an asset allocation ETF would be dramatically easier in every respect.
Hi, I’m curious if CCP would have a different opinion of Target Date Funds with the emergence of Evermore Target Date funds @ .33 MER. I notice this commenting conversation took place in 2016, so I’m checking in to see if Dan’s opinion might have changed? Thanks so much.
@Kaitlyn: Thanks for the comment. I think Evermore has done a very good job with their target-date ETFs. They stuck to plain-vanilla index funds rather than trying to get too clever, and they have kept the costs low. The same caveats still apply, such as making sure that the asset mix matches your personal risk tolerance rather than just assuming everyone with the same retirement date should use the same portfolio. But otherwise, there is a lot to like about these funds for investors who want to be hands-off.