Target-Date Funds: Fees Continue to Fall While Flexibility Powers Performance

NEW YORK (MainStreet) — Target-date mutual funds provide an elegant solution for investors looking for a prudent way to save for retirement. Many advisors don't like them – if widely adopted, these funds could eliminate a major portion of their practice, and profits. But the growth of such funds-of-funds is undeniable.

Target-date mutual funds, comprised of investments automatically adjusted for a retirement year goal, now account for $650 billion in assets as of March 31, according to Morningstar research.

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In the first quarter alone, investors poured an additional $18 billion into the funds. And fees continue to fall, with built-in investment costs lower for the fifth year in a row. The industry's average asset-weighted fee stood at 0.84% at the end of 2013, down from 1.04% in 2008.

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"Part of that movement comes from a longer-term trend favoring lower-priced index-based investments within target-date funds," writes Janet Yang, a senior fund analyst for Morningstar, in the report. "The Fidelity Freedom Index series, for instance, now holds the mantle of lowest-priced series with its 0.16% asset-weighted fee, replacing Vanguard -- with its 0.17% asset-weighted average expense ratio -- as the cost leader."

Fidelity, T. Rowe Price and Vanguard are the "do it for me" mutual fund big dogs, with a combined market share of nearly three-quarters of all target-date fund assets.

Index funds continue to thrive, as efforts to beat the market persist in failing. Morningstar's analysis of target-date funds suggests that actively-managed strategies have underperformed for each of the last three years – just as they have for the investment industry as a whole.

However, target-date fund managers that are given a bit of flexibility in their management of the funds have had a bit of success when compared to more rigidly structured competitors. Having the ability to make shorter-term tactical adjustments to their underlying investments has enhanced performance.