BOSTON -- Investors are increasingly cost conscious and providers of target-date mutual funds are responding. They're rolling out a greater number of low-cost options. These inexpensive funds come in two main varieties: those that rely on index funds and others with ETFs added in.
Target-date funds have "set-it-and-forget-it" appeal. Professional managers automatically adjust the fund's portfolio to a more conservative mix as the target retirement year approaches. That makes them appealing to investors who want to build their retirement savings without getting too involved in the process. What's more, target-date funds are often the default option for workers who don't specify how to invest contributions to their 401(k) plan.
But even hands-off investors should aim to minimize their expenses. A growing number of target-date funds aim to reduce ongoing expenses by investing in low-cost index mutual funds, exchange-traded funds or a mix of both. These funds are typically available to any investor with a few thousand dollars to start.
Here's a look at some of the latest low-cost options:
Index only, please ...
It's crucial for investors to pay attention to the fees they're paying. The majority of assets in target-date funds are held in 401(k)s, and investment management fees typically make up two-thirds of overall costs in those plans. Those fees along with the administrative costs to run the plan are shaved off the top of investment returns, whether the stock market is up or down.
Yet relatively few investors are taking advantage of the lowest-cost options. About three-quarters of all assets in target-date funds are managed, according to Morningstar. That means professionals pick stocks or bonds in the fund's portfolio in hopes of outperforming the market. Index funds seek to match the market by tracking an index, rather than trying to beat it. There's no one picking the investments, so costs are lower. And a wealth of research shows that a fund's expenses are almost always a more significant factor in long-term returns than any edge a manager can achieve.
Investor demand is growing. That's why two series of index-only target-date funds were rolled out last year: the BlackRock LifePath Index series and Lincoln Financial Group's Presidential Protected Profiles.
BlackRock also offers managed fund options, and is following the trend set by Fidelity, ING, TIAA-CREF, and John Hancock, in launching an index fund alternative to target-date lineups that include managed funds. The latest entrants boost the number of index-only target-date fund series on the market to 11.
The fee differences are substantial. The Vanguard Target Retirement and TIAA-CREF Lifecycle Index series charge an average expense ratio of 0.18 percent of assets for the low-cost institutional shares -- which 401(k) participants are typically invested in. Fidelity Freedom Index is close behind at 0.19 percent, followed by BlackRock LifePath Index at 0.28 percent.
Those compare with an average 0.81 percent for target-date funds that aren't exclusively invested in index funds, according to a recent study by BrightScope and Target Date Analytics.
The growth of index-only products and fee reductions at target-date funds offered by Allianz Global Investors, Nationwide and Pimco helped cut average expenses for target-date funds overall to 0.72 percent last year, down from 0.75 percent in 2010.
With a side of etfs ... Or an etf main dish, please
Low-cost mutual fund alternatives called exchange-traded funds have begun to appear in some target-date portfolios and the trend continues to gain momentum. Lincoln's new Presidential Protected Profile uses more than 90 percent ETFs in its portfolios, while two groups of funds from BlackRock and State Farm's LifePath series all have at least half allocated to ETFs.
Then there's iShares, which since 2008 has offered a target-date series that's 100 percent invested in the iShares family of ETFs. BrightScope and Target Date Analytics found 14 fund companies that include ETFs to some degree in their target-date portfolios, or more than one-quarter of all companies studied.
ETFs invest in a basket of stocks, bonds or commodities, and nearly all ETFs are similar to index mutual funds in that they try to keep costs low by seeking to match rather than beat the market.
In many cases, ETFs are appearing in target-date funds because the provider wants to compete by offering low-cost funds with appropriate levels of diversification and risk for investors.
Industry observers expect ETFs will become increasingly common in target-date portfolios, but won't surpass mutual funds anytime soon. Three players in target-date funds -- Fidelity, Vanguard and T. Rowe Price -- control a combined 75 percent of the target-date market, based on assets. None of those three includes ETFs in their target-date offerings.
But Brooks Herman, BrightScope's head of research, says ETFs are likely to continue appearing in more target-date portfolios run by smaller companies.
"They're looking for creative ways to say, `This is how we're getting an edge, and how we're providing good returns without taking on too much risk,"' Herman says. "For them, ETFs are part of the equation."