Best Target Date Funds for International Diversification

How to Choose the Best Target Date Fund

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Target date retirement funds (TDFs) have become increasingly popular — especially among younger investors saving for retirement. While these funds may automate asset allocation, investors should carefully examine their strategies and ensure it matches up with their own goals. This is especially true for the international diversification of TDFs, which tends to vary quite a bit between fund families and individual funds.

In this article, we will look at whether target date funds provide enough international exposure and the best funds for globally-minded investors.

Target Date Funds and Diversification

Target date funds — or TDFs — have become increasingly popular as a cost-effective, professionally-managed, age-appropriate, and diversified asset allocation that’s automatically adjusted over time. According to Investment Company Institute, roughly 7-in-10 retirement plans offer TDFs and more than a third of investors in their 20s use them compared to just 15 percent of overall investors, which suggest that they’re an emerging trend.

Critics of TDFs argue that they may provide the best asset allocation for the ‘average investor’, but no individual investor’s situation is ‘average’ by definition. Each TDF also takes a different approach in terms of its asset allocations, which makes it important for investors to carefully analyze the funds and determine the right mix for their individual situation.

Some TDFs may take on greater risk than others even if the target date is the same.

For example, Vanguard’s Target Retirement 2040 Fund (VFORX) is a fund of funds that holds a diversified portfolio of four funds. These include the Vanguard Total Stock Market Index Fund (52.5 percent), the Vanguard Total International Stock Index Fund (35 percent), the Vanguard Total Bond Market II Index Fund (8.9 percent), and the Vanguard Total International Bond Index Fund (3.6 percent).

The fund charges a modest 0.16 percent expense ratio with about $18 billion in assets.

The Fidelity Freedom 2040 Fund (FFFX), by comparison, holds a portfolio of 27 different funds that includes 64.03 percent domestic equities, 30.57 percent international equities, and only a small position in international bonds. The fund charges a higher 0.77 percent expense ratio with about $7 billion in assets under management. This means that investors in Fidelity’s TDF have less exposure to international markets than Vanguard’s TDF for the same 2040 retirement target.

Best Funds for International Investors

International diversification helps mitigate risk through investment in more than one nation or region. According to Dimensional Fund Advisors, more than 60 percent of a country’s total monthly variance is due to idiosyncratic country risk that can be diversified away. These country risks have actually increased by about 40 percent over the past 30 years, which makes international diversification increasingly important to reducing portfolio risk.

International investing is especially important for younger investors. Dimensional Fund Advisors’ study found that the benefits of reducing exposure to single country increases as the investment horizon is extended.

The benefits of diversification are also greater during periods of high volatility and market downturns even through international equities tend to become more correlated to domestic markets when they fall.

The best target date funds should allocate more assets to international markets early, while potentially reducing exposure as retirement draws near. International equities may be the most popular form of diversification, but international bonds provide another key way to diversify that shouldn’t be overlooked. Diversification of fixed income may be especially important to TDFs approaching retirement since they may mitigate domestic interest rate risks.

Some good TDF fund families to consider include:

  • Vanguard Target Date Funds
  • Fidelity Freedom Target Date Funds
  • JPMorgan SmartRetirement Funds
  • T. Rowe Price Retirement Funds
  • American Funds Target Date Retirement Funds
  • TIAA CREF Lifecycle Funds

Investors that have limited options provided by their employers should take a closer look at the prospectus of their TDFs to determine international exposure and asset allocation. Of course, investors should also carefully consider the fees associated with these funds as they could have a significant impact on returns over the long-term.

The Bottom Line

Target date funds have become extremely popular among younger generations savings for retirement but they aren’t all created equal. Investors should carefully consider their options before selecting the right TDF while looking at things like international diversification. The best TDFs should prioritize international investing early on as a way to mitigate country risk and enhance overall portfolio returns.