Special Report:Race To Retirement
Target-date fund assets exploded to $485 billion as of Dec. 31, according to Morningstar Inc. That was up 579% since 2005, the year before their popularity began to soar.
The Pension Protection Act in 2006 OK'd their use as default investments for people who are automatically enrolled in their workplace's 401(k) plan.
They're also popular among people who don't want to make their own buy and sell decisions.
U.S. diversified stock fund assets rose only 10.9% in the same period.
Target-date funds are the one-stop-shopping version of mutual funds.
All you have to do is make three decisions.
1. Pick a fund whose target date matches your retirement date.
2. Make sure that fund has the level of volatility you're comfortable with as it travels to its target date.
3. Get a handle on whether the fund stops tweaking its portfolio at the target date. Many continue to pare their growth stocks and boost their bond holdings for years afterward.
That's it. The fund manager does the rest. He picks an initial asset mix that is appropriate for your age and risk tolerance. Then he typically fine-tunes that asset mix as you age, as you approach retirement and as your desire for stability of principal grows.
Some funds aim for more growth along the way, which can make their annual gains and losses more dramatic -- bumpier.
Others sacrifice growth to give you a smoother ride.
Whatever style you choose, the fund manager makes all the changes as years go by. That spares you from having to pick the right mix of stocks, bonds and funds, changing that mix over and over as you age.
Some target-date funds are better for you than others. Investment strategies can differ, even among funds with the same target date.
And do not confuse target-date funds with lifestyle funds. Those -- sometimes called asset allocations funds -- start with an asset mix that is growth oriented or more cautious. Unlike target date funds, lifestyle funds don't change their orientation. If one starts out geared for growth, that's how it stays. If you use a lifestyle fund, you can shift by switching to increasingly conservative lifestyle funds.
Don't overlook additional investment options for your portfolio.
Many employers, consultants and regulators think target-date funds failed to live up to their hype during the financial crisis of 2008-09, says a McKinsey & Co. study. They did not shield shareholders enough from the market downturn. The most growth-oriented target-date funds -- with a 2050 or later target -- averaged a 3.73% annual gain over the five years ended March 21.
The most conservative funds, with a 2010 target date that's already occurred, averaged 4.12%.
You would have been better off in a typical U.S. diversified stock funds, which averaged 5.06%. "Diversification with funds remains a key rule," said Judith Ward, a T. Rowe Price financial planner.
Here are key points as you shop for a target-date fund:
Match your time horizon with a fund's.
That boils down to homing in on funds whose target date in their name is the same as or close to your retirement date.
How does the fund invest?
Is it full of stocks or stock funds, aiming for growth?
Is it more cautious, aiming for growth with a smoother ride?
Is it completely careful, putting a higher priority on protecting its balance than on growth?
Or is it focused on generating income with little if any attempt at price gain?
Check the facts at the fund's website or a researcher like Morningstar.com . Start by looking at how the fund is categorized. Then look at what's in the portfolio. Look at the ratio of stocks to bonds. Look at volatility measurements. Standard deviation shows how widely a fund's returns vary over a specified period.
You're trying to determine if the fund's goals jibe with yours.
And does its asset mix suit your risk tolerance? Don't buy a fund unless the answer is yes.
Does it stop adjusting its asset mix at its target date?
The reason for checking this is because some funds keep shifting to a more conservative asset mix even after their target date.
"Funds with the same target date may continue to rebalance after their target dates," said Chris Sharpe, who co-runs $164 billion in 72 target-date funds for Fidelity Investments. "And funds that continue to rebalance for the same number of years may do so in very different ways."
The time when a fund stops jiggering its portfolio is sometimes called its landing date. Check the website of a fund you're considering. "And a customer service rep can tell you how long a fund's glide path extends beyond the target date, and what sort of changes it will make," Ward said.
What is its annual expense ratio?
Target-date funds have a reputation for being expensive. Generally, they're not.
Their average annual expense ratio is 1.056%, according to Morningstar Inc. That's less than the 1.273% average for U.S. diversified stock funds.
Target-date funds' bad expense rep stem from the early days of the industry when many of them charged a fee on top of the fees charged by the funds in the fund. "Virtually all have eliminated those overlay fees," said Josh Charlson, senior mutual fund analyst for Morningstar.
The views and opinions expressed herein are the views and opinions of the author and do not necessarily reflect those of Nasdaq, Inc.
The views and opinions expressed herein are the views and opinions of the author and do not necessarily reflect those of Nasdaq, Inc.
