How T. Rowe Price Undercuts Its Own Pitch

As preachers of the target-date gospel, few have been more persuasive than the evangelists at T. Rowe Price. The Baltimore fund shop has gathered more than $30 billion in the funds, which adjust their mix of stocks and bonds as retirement grows closer, since their 2002 launch. It manages more money in the funds than all but two other fund companies.

But T. Rowe Price's newest marketing gizmo, a sleek online retirement income calculator that blends detail and investment geekery with user-friendly graphics, doesn't make the target-date case as well as you'd think. According to the tool, T. Rowe’s target-date portfolios won’t generate any more income than a traditional balanced fund. In fact, the target-date approach fares worse.

The calculator lets users tweak lots of variables, but the asset-allocation is the sexy part: You can choose one mix of stocks, bonds and cash during your savings years and another for your retirement. Or, you can "base your choice on a T. Rowe Price modeled portfolio that adjusts over time according to your expected retirement horizon" -- the same portfolio that governs the firm's target-date funds. Then the calculator generates 1,000 hypothetical market simulations to arrive at your expected retirement income.

In our test of T. Rowe Price's calculator, over investment periods of 15 years or more, the target-date portfolio leaves investors with less retirement income than a portfolio that's 60% stocks, 40% bonds -- historically, the traditional allocation familiar to most investors. How much less depends on the other parameters -- income, savings rate, time to retirement -- but all else equal, using the target-date fund means less cash for greens fees or a timeshare in Boca.

When we asked T. Rowe Price about the calculator's results, the fund company said the target-date funds fall short because they get much more conservative in retirement. “We weren’t about to launch a fund that underperformed balanced funds, which we already had,” said Ned Notzon, the chairman of T. Rowe Price’s asset allocation committee, pointing out that target-date funds are designed to become less risky once they reach the retirement date. The company’s funds ratchet down from about a 55% allocation to stocks at retirement to 40% after 15 years, to 20% after 30 years. (Other companies have their own rebalancing formulas.) A balanced fund, Notzon says, “is viable, if you’re comfortable with the risk.” That makes sense: At age 95, a prudent investor would probably be willing to trade equity returns for the stability of fixed-income.

Even so, during peak saving and investing years--what the industry calls “the accumulation phase” -- there’s no conclusive evidence that target-date funds dramatically outperform a balanced fund. According to T. Rowe research, over 33 years, a balanced fund will do better than a target-date fund in extreme market conditions; its target-date portfolios outperform in more average markets. “There’s no one fund that’s perfect for everyone in every market,” said Notzon.

Another study, by Craig Israelsen, an associate professor at Brigham Young University, is slightly more complimentary. It suggests that from 1960 to 2007, his target-date mix (which is more conservative than T. Rowe’s) would have outperformed a balanced fund by 0.3 percentage points per year. With almost 50 years of compounding, that’s not chump change: For investors making a $5,000 investment every year, that works out to a difference of about $500,000.

But none of the studies and simulations account for fees, which can sap returns faster than any tweak of the asset mix. Target-date funds cost, on average, 1.22% per year. Balanced funds: 1.09% per year. So in Israelsen’s example, the higher fees on a target-date fund may wipe out a third of the advantage.