Assessing the Impact of Fees on Performance and Shortfall Risk in Target Date Investment Funds

Abstract

Target-date investment funds are one of the fastest-growing segments in the mutual fund industry. Yet there exists only a very limited literature on their comparative risk-return characteristics. This article is the first to assess simultaneously the impact of differential fees on income accumulation and on the risk that the asset allocation inherent in target-date investment funds will generate insufficient retirement funds to furnish a minimum acceptable standard of living. The modeling framework described in this article provides a means to calculate the implied defined benefit savings rate and shortfall risk. The author finds that the opportunity cost of fees on retirement wealth accumulation is modest for aggressive target-date funds. However, for conservative funds the opportunity cost of fees can be substantial. This is a counterintuitive result. A simple rule of thumb for assessing the impact of fees on accumulated retirement wealth is also developed. The methodological framework, analysis, and results discussed in this article will help investors, plan sponsors, and policy makers better understand the risk-return characteristics of different target-date investment strategies.