If you invest in your company retirement plan then you are probably familiar with these funds. Some are created with a target retirement date, others are based on where you are in your financial life such as an Intermediate-Term Horizon or Long-Term Horizon fund. One of the benefits of these funds is that it makes investing very simple for people who do not want to worry about their investments. In a target date fund, the investments are automatically rebalanced and the allocations adjusted as the target retirement date nears. This eliminates the need for the investor to actively make adjustments to their holdings. The lifestyle funds are also simple in the fact that they are a fund of funds approach that is based on an asset allocation suitable for that particular time frame, taking some of the work out of investing.
The problem lies when investors don’t understand the holdings within their lifestyle or target date fund, and then they purchase additional investments which can simply be overlapping what they already own. I see this problem quite often when working with clients in the retirement plan, they may have 50% of their allocation in the Short-Term and 50% in the Long-Term fund. Well, all this does is create an overlap in holdings and creates an investment mix that is close to the Intermediate-Term fund.
Another issue can be when using one of these fund types as your core holding, and in an attempt to diversify you invest in a few other more specific funds or index choices. Again, if you don’t know what your target or lifestyle fund actually holds, you could be simply duplicating many of your holdings and paying additional expenses to do so. The whole point of diversifying is to create a broad investment mix to maximize returns and reduce volatility. If most of your funds have a sizable amount of overlap, the diversification is not going to be as effective.
Ultimately these can be good investment choices, but only if you take the time to understand the fund, how it works and what positions it holds. Then you can make additional investment decisions that will best benefit your diversification and investment objectives without paying additional expenses for overlapping. If you are a premium subscriber of Morningstar.com, you have a fantastic tool at your disposal. Using their Portfolio X-Ray tool you can actually look at every individual stock holding across your funds and it will alert you as to which funds overlap with similar holdings and by what percentage. This can be very helpful in determining where to address allocation issues. Of course if you are not a premium member, you may have to spend a bit more time and may have to dig into the fund holdings to determine where you stand.
Author: Jeremy Vohwinkle
My name is Jeremy Vohwinkle, and I’ve spent a number of years working in the finance industry providing financial advice to regular investors and those participating in employer-sponsored retirement plans.