Comparing the 3-fund approach to a Target Date fund

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Gatto Bialetti
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Joined: Fri Sep 06, 2019 4:45 pm

Comparing the 3-fund approach to a Target Date fund

Post by Gatto Bialetti » Sat Nov 16, 2019 8:55 pm

In a recent thread that has dropped off of the front page, one long time poster stated that when he retired he wanted the allocation that is provided by the 2015 TDF, and so that's where he put his money. Given that its expense ratio is ~+.1% higher than what you'd pay using total stock/intl/bond funds, I wonder why one would opt to pay the difference.

It's certainly simple. With the other method it would require rebalancing periodically.

So, over time, how much does it cost to do it that way? How to figure that out, out of curiosity?

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fortfun
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Re: Comparing the 3-fund approach to a Target Date fund

Post by fortfun » Sat Nov 16, 2019 9:28 pm


rkhusky
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Re: Comparing the 3-fund approach to a Target Date fund

Post by rkhusky » Sat Nov 16, 2019 10:10 pm

Gatto Bialetti wrote:
Sat Nov 16, 2019 8:55 pm
In a recent thread that has dropped off of the front page, one long time poster stated that when he retired he wanted the allocation that is provided by the 2015 TDF, and so that's where he put his money. Given that its expense ratio is ~+.1% higher than what you'd pay using total stock/intl/bond funds, I wonder why one would opt to pay the difference.

It's certainly simple. With the other method it would require rebalancing periodically.

So, over time, how much does it cost to do it that way? How to figure that out, out of curiosity?
You could use portfoliovisualizer.com to determine the past difference. Whether that would hold in the future is anyone's guess.

edit: actually if would be difficult to compare to a tdf that was changing its allocation over time. And it is actually difficult to compare to fixed allocations like Vanguard's Lifestrategy because they changed their international allocation not many years ago. Given that the difference between a TDF and a rebalanced 3-Fund with a similar glide path would expected to be small, small differences in implementation could swamp the small ER difference.

edit2: Using PV and comparing a 42/18/24/16 portfolio of Total Bond/Total Int'l Bond/Total Stock/Total Int'l (rebalanced monthly) versus LifeStrategy Conservative Growth yields a CAGR of 5.61% for the former and 5.65% for the latter (Sharpe Ratio of 1.02 for the former and 1.04 for the latter). Too close to call. The available data is for Jan 2014 - Oct 2019. (Rebalanced yearly has CAGR of 5.57% and Sharpe Ratio of 1.01)

Using PV and comparing a 60/24/16 portfolio of Total Bond/Total Stock/Total Int'l (rebalanced monthly) versus LifeStrategy Conservative Growth yields a CAGR of 5.86% for the former and 5.98% for the latter (Sharpe Ratio of 1.06 for the former and 1.08 for the latter). Again, too close to call. The available data is for Jan 2011 - Oct 2019. (Rebalanced yearly has CAGR of 5.89% and Sharpe Ratio of 1.07)

Expense ratio doesn't appear to hurt LifeStrategy Conservative Growth.

anon_investor
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Re: Comparing the 3-fund approach to a Target Date fund

Post by anon_investor » Sat Nov 16, 2019 10:52 pm

Gatto Bialetti wrote:
Sat Nov 16, 2019 8:55 pm
In a recent thread that has dropped off of the front page, one long time poster stated that when he retired he wanted the allocation that is provided by the 2015 TDF, and so that's where he put his money. Given that its expense ratio is ~+.1% higher than what you'd pay using total stock/intl/bond funds, I wonder why one would opt to pay the difference.

It's certainly simple. With the other method it would require rebalancing periodically.

So, over time, how much does it cost to do it that way? How to figure that out, out of curiosity?
I think the 3 fund portfolio vs TDF has tax advantages that make it really hard to calculate long term. Specifically, with 3 fund you have the benefit of asset location and can keep all your bonds in 401k (or TIRA if you aren't doing back door roth contributions). Also in lower tax brackets, you can keep your international in your taxable account to benefit from the foreign tax credit (or keep all your international in tax advantaged accounts in higher tax brackets when that makes more sense tax wise). Whereas with a TDF you get none of those choices. Also, if I am not mistaken, the TDF does give off some capital gains distributions, which you may be able to completely avoid by doing 100% of your re balancing in your tax advantaged account.

TDF is like 3 fund portfolio with training wheels, its easy, but has some limitations at least from a tax perspective.

JBTX
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Re: Comparing the 3-fund approach to a Target Date fund

Post by JBTX » Sun Nov 17, 2019 12:31 am

With TDF fund rebalancing is automatic. That should be worth something. 0.1% is a relatively small price. In some 401ks you can get institutional ERs of.07 or.08.

In terms of tax benefits of 3 fund vs TDF, for many the difference is likely marginal. I've gone to mostly target date funds in some 401ks with institutional ERS.

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