(Dow Jones) Target-date funds are supposed to improve the way millions of Americans save for retirement. But the funds' high fees could end up adding years to the time many workers will need to punch the clock.
The funds, which hold a mix of stocks and bonds that grows steadily more conservative as investors' retirement or "target"-date approaches, have been one of the fastest-growing corners of the mutual-fund business, with about $330 billion invested today, up from less than $70 billion five years ago. But they have sparked complaints of failing to adequately protect investors after some posted wide losses during the financial crisis.
A new report from the U.S. Government Accountability Office, which was released last week, highlights another key aspect that might prove a bigger flaw in the long run: how much these investments cost.
While many investors may barely notice investment fees, the GAO says that some target-date investors may pay up to nine times what others do. Investors in funds run by Vanguard Group pay average annual fees amounting to just 0.18% of their invested assets, while those in OppenheimerFunds Inc.'s Oppenheimer LifeCycle Series funds pay 1.68%, according to investment-research firm Morningstar Inc.
OppenheimerFunds says its target-date fees are likely to fall as the funds grow in size, helping spread out fixed costs. It adds that under a different methodology for calculating costs, its funds' average fees are a slightly lower 1.44%.
Fees are so important because every dollar spent on investment management translates directly into lower fund returns. Throughout the years that many workers save and invest in their 401(k)s, even seemingly negligible cost differences can amount to tens of thousands of dollars in lost gains.
Investment fees "can take a big chunk or a small chunk out of a person's return," says Robyn Credico, a senior consultant at employee-benefit consulting firm Towers Watson. Her research suggests a salaried worker earning $125,000 a year and saving 12% of his salary every year from age 25 to 62 in a target-date fund with a 0.2% annual fee would end up with roughly 12 additional years of retirement income than a similar worker in a fund with a 1% fee. The calculations assume investors withdrew 70% of their final pay each year in retirement, including Social Security benefits.
Fund companies say some target-date investors pay more than others for a number of reasons. Some pricier funds are designed for investors in plans set up by small employers and reflect those plans' comparatively high fixed costs. Another big factor: Most target-date funds embrace active stock and bond picking-in which fund managers gamble they can earn back any extra fees they charge investors by posting above-market returns-over a passive index-fund approach that merely seeks to match the market's returns. While academic research shows this is unlikely, many companies believe they can beat the odds.
"Overall, it's difficult for active managers to outperform, but not all active managers are created equal," says Jerome Clark, head of T. Rowe Price Inc.'s target-date family. "Good active management is a better place to be, if it's at a reasonable cost."
Unlike mutual-fund investors who pick funds through brokers or on fund company websites, target-date holders typically don't have any say in which fund they buy. They're stuck with the one picked by their employer.