Mutual Funds
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| | Mutual Funds
No guts, no glory, even in retirement funds
Life-cycle funds are designed to take the risk out of investing for retirement, but some play it too safe -- and water down the return. Here's one significant exception.
By Timothy Middleton
Life-cycle mutual funds are designed to take the risk out of investing for retirement. They also are likely to let you down in retirement.
At least that's what fund company T. Rowe Price (TROW, news, msgs) is saying: That playing it conservative with your nest egg is the wrong strategy.
"It's quite likely when you retire you might live 20 to 30 years," notes Ned Notzon, chairman of Price's asset-allocation committee, which oversees its retirement funds. "So a portfolio of bonds is not really safe; it's not going to last. You must have capital appreciation to keep up with the cost of living."
Life-cycle funds are portfolios with dynamic mixes of stocks and bonds. They are sold to investors based on how close they are to retirement. The closer you are to retiring, the more the mix tilts toward bonds.
Price has defied conventional wisdom by loading its funds up with stocks, including those of foreign companies. Because of that, the Price funds have generated returns as much as 80% better than rivals Fidelity Investments and the Vanguard Group.
Investors like what they see. Starting from nothing three years ago, Price Retirement funds have gathered a huge following among investors, due to their sizzling performance.
Last year the largest life-cycle fund, Fidelity Freedom 2020 (FFFDX), saw its assets grow 38.6%. T. Rowe Price Retirement 2020 (TRRBX) swelled 400%.
This could be the first instance of intelligent performance chasing I've seen in more than 20 years of writing about financial markets. And "performance chasing" and "T. Rowe Price" seldom appear in the same sentence. That's what makes it such an unlikely challenger to, in particular, Fidelity.
Performance chasing has been Fidelity's principal theme since Ned Johnson and then Peter Lynch made Fidelity Magellan (FMAGX) a household name via the fund's astonishing returns. Price has been the opposite, quick to close popular funds to prevent them from being transformed, as Magellan has been in the last 15 years, into bloated corpses.
But Price's new smart and aggressive approach to retirement investing is winning, and the real winners are investors. Price's adroit balance of risks -- the volatility of stocks vs. the likelihood of watching a life's savings disappear before their time -- blazes a trail other fund companies are likely to follow.
Targeting a retirement date
Mutual funds that invest in other funds -- known as funds of funds -- were first calibrated to an investor's pain threshold: Bond-heavy funds for the timid and equity-heavy types for the bold. Lately, however, the life-cycle variety has gained dominance -- funds that become increasingly conservative as investors age, putting more stress on preserving capital than enhancing it.
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Fueling this trend is explosive growth among retirement-oriented investments, which at the end of 2004 accounted for 24% of the mutual fund industry's total assets of $5.435 trillion, excluding money market funds, according to the Federal Reserve.
Through employer plans like 401(k)s and private ones like IRAs, nest-egg investors are drawn to life-cycle, or target-maturity, funds because they do everything from investing in individual securities to shifting assets depending on market conditions and the target shareholder's age.
Fidelity Freedom 2010 (FFFCX) is designed for people who expect to retire about that time; Fidelity Freedom 2030 (FFFEX) for those a generation younger. The latter portfolio has nearly twice the weighting in equities as the former. Vanguard Target Retirement funds with similar maturities have similar weightings.
But T. Rowe Price's weightings in similar portfolios are radically different.
| Clear difference: T. Rowe Price vs. the Big Two | | Fund | Equities | Fixed
income | 12-month
performance | | Fidelity Freedom 2010 (FFFCX) | 46% | 54% | 3.3% | | Vanguard Target Retirement 2015 (VTXVX) | 48% | 52% | 4.8% | | T. Rowe Price Retirement 2010 (TRRAX) | 65% | 35% | 6.0% | | | | | | Fidelity Freedom 2030 (FFFEX) | 80% | 20% | 4.4% | | Vanguard Target Retirement 2035 (VTTHX) | 77% | 23% | 6.1% | | T. Rowe Price Retirement 2030 (TRRCX) | 89% | 11% | 7.4% |
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Note: Data as of April 6, 2005.
Source: Morningstar Inc.
T. Rowe Price's Retirement 2010 (TRRAX) has 40% more of its assets in stocks than its Fidelity rival, and, in the last 12 months, has returned 82% more. T. Rowe Price Retirement 2030 (TRRCX) has 11% more equity exposure and has generated returns 68% higher.
The supercharged part of that out-performance is partly due to a much higher weighting of foreign stocks in the T. Rowe Price portfolios -- 63% more in the 2010 portfolio and 22% more in the 2030 fund. Foreign equities have greatly outperformed domestic stocks in the last year.
T. Rowe Price's strategy is driven by Monte Carlo analysis, the study of probable outcomes based on historical data. No investment is guaranteed to perform as it has in the past, but when myriad scenarios point in the same direction, it's the most sensible course to follow. The name comes from the approach's similarity to calculating odds in a casino.
T. Rowe Price assumes retirees will need to draw around 4% to 5% of their investments every year to live on. A bond-heavy account could be used up in less than 15 years; only the capital-appreciation potential of stocks enables them to outpace the twin burdens of taxation and inflation.
A clear, and lasting, winner
The T. Rowe Price portfolios haven't only outperformed in recent months. In 2003 the Fidelity 2010 fund returned 17.1%; T. Rowe Price 2010 spurted 23.8%. In that year Fidelity 2030 shot up 28.4%, but T. Rowe Price 2030 did even better, up 30%.
In coming years, T. Rowe Price's methodology all but guarantees it will continue to outperform until two conditions are met: Interest rates fall steeply and stocks crash. Both possibilities are remote: Rates are still historically low, and the stock market already crashed in 2000-2002. Stock debacles of that magnitude have happened in modern times less than once a generation.
Moreover, of the most recent 12 months, nine have been hostile to stocks and eight to bonds, but all of these funds have remained firmly in positive territory.
Full disclosure: I have my largest retirement account with T. Rowe Price (although I'm not invested in its life-cycle funds). I own or control multiple smaller accounts with Vanguard (again, no life-cycle funds) and one with Fidelity (ditto).
They're all fine companies, and I can make money with each. If I were to invest in life-cycle funds, however, my choice would be clear: There's T. Rowe Price and there's everybody else.
At the time of publication, Timothy Middleton didn't own any securities mentioned in this article.
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