The Art of Comparing TDF and Balanced Fund Performance

The outputs of a hypothetical model based on historical net asset values for balanced funds and target-date funds show just how complicated it can be to compare the relative merits of the two approaches to asset allocation. As it turns out, balanced funds, though less popular, might deserve another look.

In 2007—around the time the Department of Labor (DOL) was finalizing its guidelines regarding permissible qualified default investment alternatives (QDIAs)—target-date funds (TDFs) were the default investment for 33% of plans responding to the annual PLANSPONSOR Defined Contribution (DC) Survey, while 20% of plans used stable value funds, 16% used a balanced fund and 6% used managed accounts.

More than a decade later, balanced funds and managed accounts, both of which offer the same safe harbor fiduciary protections as target-date funds—have become afterthoughts in the QDIA selection process and are now only used by 5% and 4% of plans, respectively. TDFs are now being used by 76% of plans.

Given its dominant popularity as the default investment, it is natural to ask how TDF performance has compared with the alternatives—particularly balanced funds.

To answer this question, PLANADVISER’s Research and Survey team created a model that follows the “career” of an employee who started investing in one of a number of commonly used balanced funds and 2030 target-date funds around 2008. The model uses reported daily net asset value (NAV) prices to determine how many shares the employee would purchase each pay period and assumes that all dividends and capital gains were reinvested when paid. The model, in addition to comparing outcomes across the different balanced funds and TDFs, can also account for different deferral rates and employer match structures.

The goal of this exercise was to understand what the participant’s actual account balance would have been with each investment after 12 years of continuous, uninterrupted contributions. Although past performance is not indicative of future results, tracking actual outcomes based on actual data shows what might be considered actual results for participants from 2008 to 2021. As it turns out, balanced funds might deserve a closer look.

The Basic Findings

While the research team is still refining the model, the preliminary findings may surprise some. Overall, participants invested in balanced funds were very competitive with identical participants in 2030 target-date funds. In many cases, balanced funds outperformed the 2030 TDFs, with the average final account balance for the balanced funds in the first tests outperforming the average 2030 target-date fund by almost 6%. What was equally surprising was the range of overall outcomes among all funds tested, with the best performing fund returning a final account balance that was 26% higher than the lowest performing fund.

As the research team emphasizes, much work still needs to be done to improve the model and understand the factors influencing these results. The team looks forward to sharing additional findings from this project later in the year, but what seems clear from its early work is that balanced funds might deserve a more prominent place in the evaluation and selection of a plan’s QDIA.

A Few Notes of Caution

The snap reaction to this data could be that balanced funds are “better,” because they increased the ending savings amount by 6% in this theoretical example. In reality, however, there is some important context to consider before drawing any conclusions from this basic analysis.

The first point relates to market returns and whether one considers “baseline” market growth—that is, the rate of growth that would have been expected during this time frame based on historical return assumptions—or the “accelerated” market growth that has actually taken place since the mid-1990s. This is to say, it should be obvious that a fund that has higher equity allocations would have performed better during a period of accelerated growth. So, while one TDF with a higher-than-average equity allocation considered by the model may do better in this analysis, which considers the time frame of 2008 to 2021, a substantially different outcome might have been reached had the market returns differed.

Should retirement plan investors and their sponsors believe the outsized growth will continue? And, furthermore, it is necessary to ask what the return picture looked like during the theoretical savings journey mapped by the model. If one were to tabulate the outcomes after five or 10 years, the results are different.

Where the Rubber Hits the Road

Participant surveys conducted by the PLANADVISER/PLANSPONSOR research team have consistently shown that investors are willing to trade lower fees/returns for less market risk. This fact adds yet another layer of complexity in comparing potential options for a plan’s QDIA.

In the end, one cannot merely point to the data above and take this as proof that the typical retirement plan investor needs to use a TDF or a balanced fund. Furthermore, a given starting salary entered into the model (say, $40,000) that is assumed to grow every year might not be reflective of today’s middle-income or lower-income families.

In sum, investment models like this one are most helpful for demonstrating the multidimensional analysis that must go into the prudent choice of a QDIA, and their ability to provide definitive answers to highly nuanced questions may be limited.