Each week, one of ourinvesting experts answers a reader's
question in our the Q&A column at our sister site,
InvestingAnswers.com
. It's all part of our mission to help consumers build and
protect their wealth through education. This week's
question will be answered byInvestment Analyst David
Sterman:
Many of us invest for one reason: to build a big enough nest
egg for retirement. Good old-fashionedstock picking is the
preferred route for many investors but can be a bit daunting for
the novice investor. This reader's question addresses another
type of investment that can provide you with a solid retirement
strategy.
Q.
"I'm a long way away from it, but I'm starting to think about
investing for retirement. I've heard of these mutualfunds with a
year attached to them and you pick the one that's closest to the
year that you expect to retire. How do those work exactly? And are
they good?" -- Paul, Manhattan, Kan.
A.
Paul, you're talking about "target-date" funds, and the short
answer is, yes, they are a solid investment vehicle. Before we look
at your various options with these funds, let's see how they
work.
These funds acquire a set of assets and place them into afund
that is aimed at investors of a specific age. Funds that are aimed
at people close to retirementload up on low-riskinvestments such
asbonds and Treasury Bills, along withstocks that sport stable and
soliddividend yields.
For investors who don't plan to retire for several decades,
there are target-date funds that own a riskier but perhaps
higher-returning set of assets. This follows the longstanding
investing maxim that the greater the number of years until
retirement, the more aggressive an investor should be. These funds
steadily adjust their mix of holdings as the years pass, focusing
on more conservative investments as the end date of the portfolio
draws closer.
Though these funds have been around for two decades, they've
recently soared in popularity, thanks to the Pension Protection Act
(
PPA
) of 2006. That act allowed employers to automatically enroll their
employees into 401(k) plans, and target-date funds became an
acceptableoption , especially for novice investors. Before the PPA,
less than $200 billion was invested in these funds. That figure has
quickly soared to nearly $500 billion.
In response to this popularity, financial services providers are
nowoffering a wider range of investment options. Fidelity, Vanguard
and T. Rowe Price have the widest range of offerings, though other
fund firms also now sponsor target-date funds. It's probably best
to stick with the Big Three, as smaller fund firms are always at
risk of shuttering a fund that has too few assets under
management.
Key fund families for you to consider include:
-- Fidelity's "Freedom funds," each of which has a date attached
to them. For example, the Freedom 2030 fund is suitable for
investors in mid-careers, while the Freedom 2055 is ideal for
investors who have only recently joined the workforce. These funds
carry a 0.89% annualexpense ratio , and analysis by financial data
firm Morningstar found that "long-term performance has been merely
decent."
-- T. Rowe Price Retirement Target-Date Funds sport a more
reasonable 0.7% annual expense ratio, yet have delivered solid
returns compared to the peer group. That's partially attributable
to a more aggressive investing approach, which has paid off while
the markets have rebounded in recent years, though "there's more
driving performance than just thestrategic asset allocation ,"
Morningstar suggests. The fund-rating firm thinks T. Rowe Price's
fund managers have proven to be especially adept stock pickers,
which could continue to lead to relative outperformance for these
funds.
-- The Vanguard Target Retirement Target-Date Funds get high
marks for a fairly conservative approach. "The high-quality bias of
the stock andbond portfolios caused these funds to lag their
competitors during 2009's speculative-driven rally, but they held
up better than most during 2008's financial crisis," according to
Morningstar's analysts. Perhaps the strongest endorsement for these
funds: a very low 0.18% annual expense ratio. During the course of
many years, the smaller bite from expenses means moremoney stays in
your fund -- and not in the firm's coffers.
Keep in mind that investors in target-date funds shouldn't
equate low risk with no risk. Indeed, in themarket meltdown of 2008
and early 2009, even the most conservative target-date funds
slumped in value. The good news: Those losses were eventually
recovered, and these funds have risen in tandem with the broader
stock market in recent years. Still, expect further bumps in the
road as you wend your way toward retirement. As a good rule of
thumb, keep several years' worth of living expenses in short-term
bonds andCDs on hand, so you can tap those moreliquid funds if
needed amidst another stock market rout.
Action to Take -->
The right fund for you depends on your risk tolerance. Even among
target-date funds with similarexpiration dates you'll find a vastly
different mix of assets. That's why you should compare and contrast
the holdings of funds offered by the leading 401(k) providers such
as Fidelity, Vanguard, T. Rowe Price and others.
This article originally appeared on InvestinAnswers.com:
These
Super-Simple Funds Take The Work Out Of Retirement Investing
-- David Sterman
David Sterman does not personally hold positions in any
securities mentioned in this article. StreetAuthority LLC does not
hold positions in any securities mentioned in this article.