For Investors Who Miss Their Retirement Targets, Fees in TDFs May Be to Blame
Leeds research finds target-date fund sponsors overcharged investors by $30 billion from 2008 to 2019.
If, in 2006, you had put $1 million into one of the nation鈥檚 largest target-date funds, that investment today would be worth about $2.2 million.
Not a bad return, right? But TDFs have substantial fees attached to them. If you had built a similar portfolio for yourself, your returns would have been closer to $2.5 million.
鈥淭hat鈥檚 something like the outstanding mortgage balance of your average household, or the four-year tuition bill for one of your kids,鈥 said Shaun Davies (ApMath, Econ鈥05), associate professor of finance and research director of the Burridge Center for Finance at the university of Colorado 麻豆影院鈥檚 Leeds School of Business.
Forthcoming research from Davies and his co-author, David Brown (PhDBus鈥14), found that from 2008 through 2019, TDF sponsors collectively overcharged nearly $30 billion, even after factoring the cost of business for those sponsors. This work is an expansive update to previously released research looking at TDFs.
You might think Davies is an enemy of TDFs, but he鈥檚 not鈥攈e just opposes the opacity of their fees.
鈥淭DFs are a phenomenal investment innovation,鈥 Davies said. 鈥淚t鈥檚 a one-stop shop for a diverse asset allocation that gets rebalanced as market conditions change. But the average investor has no understanding of the fees they鈥檙e paying in these funds. This opaqueness is clearly unfair.鈥
So what鈥檚 an investor to do? It鈥檚 too onerous to create a basket of funds that mirrors a TDF, regularly rebalance it and still hold down a day job. Davies and Brown created a simplified version of the replicating funds called PROF鈥擯assive Replication Of Funds鈥攚hich distills a TDF鈥檚 holdings into a manageable portfolio of seven holdings, as opposed to 30 or more.
Even with this tool鈥攚hich they hope to soon offer for free online鈥擠avies is dubious that people will get out of the habit of selecting the default investment option offered by their 401(k) provider.
鈥淩eally, this is about adding transparency to an opaque market,鈥 he said. 鈥淧eople don鈥檛 know how much they鈥檙e overpaying. If we could have this as a benchmark on Morningstar, that would lead to transparency about these practices. Maybe investors鈥攐r HR departments who preselect retirement benefits鈥攃an choose a TDF with a smaller spread between the TDF and the replicating fund fees.鈥
The Pension Protection Act of 2006 made TDFs the default investment allocation for corporate retirement plans. If you didn鈥檛 make a selection when your employer enrolled you into its 401(k), you鈥檙e among the 40 million Americans invested in a TDF.
Replicating funds鈥攖he vehicle proposed in this research鈥攐ffer the benefits of TDFs without the high fees, which helped them outperform TDFs by 10.5% from 2008 to 2019.
That extra competition, he said, should put pressure on these companies to lower the fees they charge.
Critics of Davies鈥 research say TDFs have to charge fees as a cost of doing business, but the replicating funds attempt to take that into account, also. He looked at Vanguard, which offers the lowest fees on TDFs, and found those fees are about 10 basis points more than the company charges on typical exchange-traded funds. Those cost-of-business charges are factored into the $30 billion in fees Davies cites in the paper.
鈥淚 can see real opportunity for this research to make this a more fair playing field for investors.鈥
Shaun Davies
The work caused quite a stir when Davies and Brown , which were featured in and , but their new paper reaches the same conclusions with a far richer inputs, including data from both Thomson Reuters and the Center for Research on Securities Pricing. Now, he and his coauthor are busy getting more visibility for the paper, including a presentation at the Center for Financial Planning鈥檚 virtual , in November.
鈥淭hat鈥檚 an important one to us because you have financial planners, regulators and the press there,鈥 he said. 鈥淪ometimes it鈥檚 difficult to see where my other research can have real-world impact. This is unique鈥攊t has immediate implications for an industry that lots of our family members and friends play in, but don鈥檛 understand.
鈥淚 think everyone has that fear in the middle of the night of having enough money to retire comfortably. I can see real opportunity for this research to make this a more fair playing field for investors.鈥