How to build your own target-date fund (for cheap)

One-stop “target-date” funds appeal to investors who want to own a mix of stocks and bonds that match their investing goals, without buying a ton of different assets. They remove a lot of guesswork for folks who are just getting started and they can work well as a core holding, allowing savers to add more daring or personally appealing positions to their mix. But some retail investors, balking at the fees, are steering clear of target-date assets and building their own versions instead.

So let’s check out how you might do that and weigh up whether it’s even worth the effort.

First, what are these investments exactly?

Target-date funds are a professionally managed portfolio of stocks and bonds that shake up the asset mix as the investor speeds toward a set end date – typically, retirement. They’re a wildly popular savings tool and cost an average of 0.68% a year, according to Morningstar.

In the UK market, Vanguard’s LifeStrategy line of funds is the market leader, with around £30 billion ($40 billion) managed for British investors at a cost of 0.22% a year, (so, $2.20 on a $1,000 investment). BlackRock’s popular MyMap range does a similar job for just 0.17%. The funds contain some passive fund building blocks – with the underlying investment mix varying depending on risk. And the more adventurous the fund, the higher the weighting to stocks, and the lower the weighting to bonds.

Vanguard’s portfolio is a basket of its own index funds. The five funds in the range have different stock weightings: 20%, 40%, 60%, 80%, and 100%. The 100% Equity strategy contains ten funds, while its 80% Equity fund owns 14. The rest is held in bond funds. Individual costs range from 0.06% for a simple stocks tracker to 0.23% for its emerging market (EM) index. Bond exposure consists of trackers for corporate, government, and index-linked bond funds.

BlackRock’s MyMap range does a similar job but uses its own iShares line of tracker funds for the building blocks. It has five options, ranging from 25% in stocks to everything in stocks. Some of its funds also give investors exposure to alternative assets, like commodities and real estate.

So, how can you replicate them?

For a broad basket of global shares, the cheapest way to go is the L&G Global Equity ETF GBP, which charges just 0.1%. This ETF tracks the Solactive Core Developed Markets Large and Mid Cap Index.

You could spend slightly more – 0.12% – for the SPDR® MSCI World ETF. It tracks the MSCI World Index, which consists of some 1,500 companies across 23 developed markets. Generally speaking, it’s more expensive to track EM stocks, because those shares are less frequently traded and are less liquid, so investors tend to pay a bit more when they buy them.

But that’s not to say you can’t get them at a reasonable price. The HSBC MSCI Emerg Mkts ETF GBP charges just 0.15% to track an index that has around 1,400 big-cap and mid-cap EM stocks. Or, for the same money, investors could also buy into a basket of EM shares that exclude Chinese shares, which currently account for about 30% of the index. The Amundi MSCI Emerging Mkt Ex China ETFAcc EMXC charges 0.15%.

The cheapest way for a British investor to grab stocks that are close to home is with the Amundi UK Equity All Cap ETF, which charges just 0.04%. It’s one of the cheapest ETFs of any kind available to UK investors and it tracks the Morningstar UK Index rather than the FTSE 100. And that could be particularly appealing right now as interest rates fall, giving a boost to some of the country’s more indebted, mid-sized businesses. After all, while the FTSE 100 houses the 100 heftiest UK-listed companies, the Morningstar index houses more than 300 firms in total – some big and some not-so-big.

To gain some thrifty exposure to the US flagship S&P 500, a British investor can skip the popular ETF trackers and go for the Lyxor Core US Equity (DR) ETF - Dist GBP instead. It charges just 0.04% and tracks the Morningstar US Index, which has nearly 700 stocks under its umbrella.

Or, they might go for the Invesco MSCI USA ETF and the Invesco S&P 500 ETF GBP, both of which charge just 0.05%. They’re the two cheapest ways to gain exposure to either the S&P 500 or the MSCI USA Index.

What’s the opportunity here?

OK, let’s agree: the cost of LifeStrategy is greater than the sum of its parts. That said, investors also benefit from the fact that Vanguard keeps an active, constantly updating view on which markets are most attractive at any given time. It also “rebalances” the fund regularly, so it doesn’t end up heavily skewed toward (or against) one region or sector. And that might smooth out some of the risks that folks face.

Right now, for example, LifeStrategy has about a quarter in the UK, compared with just 4% for a typical global shares tracker. It’s one-third invested in American stocks, which pales in comparison to the 69% share you’d find in a global index.

And, sure, backing cheaper British stocks may turn out to be the right call, but it has cost investors dearly over the past decade as America’s technology giants have rocketed higher. Retail investors who build their own portfolios, meanwhile, can take a view on which market might perform best.

On the other hand, trading costs can add up for retail investors who go it alone, and that can become a drag on performance. However, given that it is possible to cut your fees roughly in half, investors who are comfortable building and holding their own passive portfolios can make savings that will add up over long investment periods.