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120 Rule vs. Target Retirement Funds

Posted By Jim On 04/12/2010 @ 7:13 am In Retirement | 17 Comments

Have you ever heard of the 120 Rule? The 120 Rule is a basic asset allocation rule. Take your age and subtract it from 120. That is the percentage you should be invested in stocks and the balance should be in bonds. If you’re 40, then you should have 80% in stocks and 20% in bonds. If you’re 50, then 70% stocks and 30% bonds. It’s one of those age old “rules of thumb” that can be a good starting point for deciding asset allocation but bad as an end point. As a retiree at the age of 65, do you really want the majority (55%) of your investments in stocks? Maybe, maybe not, but your reasoning should go beyond the 120 Rule.

When it comes to Target Retirement or Lifecycle funds, not all funds are created equally.

Let’s compare the funds from Vanguard, Fidelity, TIAA-CREF, and … Each broker has a fund that ends in 0 or 5 until 2040, or thirty years from now. We’ll look only at the 0’s, just for simplicity, and compare how each one’s assets invested in stocks will change over the years. We are making one big assumption, that each of the fund families will change its asset allocation the same way. In other words, the allocation of the Vanguard Target Retirement 2030 today will be the same as the Vanguard Target Retirement 2035 in five years. And we’ll use the 120 Rule as our benchmark, even though we can agree that in general it’s a bad idea to end there.

Finally, we assume that the year of the fund corresponds to the investor’s retirement age of 65.

Broker Income 2020 2030 2040 2050
120 Rule 55% 65% 75% 85% 95%
TIAA-CREF 39.30% [3] 65.54% [4] 81.58% [5] 88.93% [6] 88.87% [7]
Vanguard 29.75% [8] 67.33% [9] 82.22% [10] 88.92% [11] 88.89% [12]
Fidelity 19.45% [13] 59.91% [14] 73.98% [15] 79.22% [16] 84.49% [17]
T. Rowe Price 40.97% [18] 73.04% [19] 84.40% [20] 88.58% [21] 88.53% [22]

For the visually inclined:

My thoughts:

  • I wouldn’t put too much stock in the difference between each broker’s allocation and the 120 Rule for the Income column. Income funds are meant for people in retirement, whether they’re 65, 75 or 85, so comparing it with the baseline isn’t going to be that interesting. Comparing them to each other, now that’s very intriguing. T. Rowe has nearly 41% in stocks while Fidelity, who overall is more conservative, has less than 20%.
  • Fidelity, in green, is very conservative compared to the other three. Is this a good or bad thing?
  • On the flip side, T. Roe, in blue, is slightly more aggressive than its peers, though they all seem to converge at the 2040 and 2050 funds (excluding Fidelity).
  • The farther we are from retirement, the more these funds agree, though they have a bit of an identity crisis. There is very high agreement in the 2040 and 2050, when you exclude Fidelity, but it’s weird that some of the funds have fewer stocks in 2050 than 2040. This could be the result of underlying factors and not strict asset allocation decisions.
  • Clearly, not all funds are created equal. Besides looking at expense ratios, which we didn’t, you need to look at the underlying asset allocation to make a good determination of which one is right for you.
  • I wonder if asset allocations are less aggressive because the funds don’t want to take as much risk as the rule says you should. Or, is the rule simply a gross simplification? Rules of thumb are supposed to be easy, compact, but accurate… but it doesn’t appear to be accurate. Or maybe it’s too much of a simplification? One thing is clear, each of the allocations follows a similar curve.

There are two big lessons from this exercise:

  • Rules of thumb are meant to be questioned. There’s a reason why I like writing Devil’s Advocate posts that question conventional wisdom. What worked twenty years ago may no longer apply and periodically we need to review our assumptions and question whether these rules are still accurate enough to be used as shortcuts.
  • Not all funds are created equal. It’s now been drilled into our heads that we should review expense ratios but with the advent of these bite-sized retirement funds, where you pay someone to do the thinking for you, you might fall into the trap of thinking they’re all the same. They’re not.

I’m curious if you have any observations about the data and if so, please share it. I’m eager to get a discussion on this as I’m not a seasoned data analyst so there might be easy patterns I’m missing!

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URLs in this post:

[1] Tweet: http://twitter.com/share

[2] Email: mailto:?subject=http://www.bargaineering.com/articles/120-rule-vs-target-retirement-funds.html

[3] 39.30%: http://www.google.com/finance?q=TLRRX

[4] 65.54%: http://www.google.com/finance?q=MUTF:TCLTX

[5] 81.58%: http://www.google.com/finance?q=MUTF:TCLNX

[6] 88.93%: http://www.google.com/finance?q=MUTF:TCLOX

[7] 88.87%: http://www.google.com/finance?q=MUTF:TLFRX

[8] 29.75%: http://www.google.com/finance?q=MUTF:VTINX

[9] 67.33%: http://www.google.com/finance?q=MUTF:VTWNX

[10] 82.22%: http://www.google.com/finance?q=MUTF:VTHRX

[11] 88.92%: http://www.google.com/finance?q=MUTF:VFORX

[12] 88.89%: http://www.google.com/finance?q=MUTF:VFIFX

[13] 19.45%: http://www.google.com/finance?q=MUTF:FFFAX

[14] 59.91%: http://www.google.com/finance?q=MUTF:FFFDX

[15] 73.98%: http://www.google.com/finance?q=MUTF:FFFEX

[16] 79.22%: http://www.google.com/finance?q=MUTF:FFFFX

[17] 84.49%: http://www.google.com/finance?q=MUTF:FFFHX

[18] 40.97%: http://www.google.com/finance?q=MUTF:TRRIX

[19] 73.04%: http://www.google.com/finance?q=MUTF:TRRBX

[20] 84.40%: http://www.google.com/finance?q=MUTF:TRRCX

[21] 88.58%: http://www.google.com/finance?q=MUTF:TRRDX

[22] 88.53%: http://www.google.com/finance?q=MUTF:TRRMX

Thank you for reading!