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Target Date Funds: Choosing Among Different Options

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Target-date funds continue to soar in popularity. Since their debut in the mid-1990s, they have amassed $641 billion in assets as of March 31, according to the Investment Company Institute.

But target-date funds are not all alike.

Take the target date 2021-2025 as an example. Going into Friday, average annual returns over the past five years ranged from a high of 14.06% for $15.5 billion T. Rowe Price Retirement 2025 to a low of 10.07% for $2.4 billion Wells Fargo Advantage Dow Jones Target 2025 , says Morningstar.

And differences are common in funds with other target dates.

So how should an individual shareholder choose a fund? Start by deciding when you want to begin taking income from the fund. At retirement? Ten years later?

That depends a lot on whether you'll have other retirement income such as Social Security and a traditional pension, says Mathew Jensen, director of target-date strategies for Fidelity Investments.

Say a hypothetical Joe Gunn will start withdrawals five years after retirement.

Gunn shouldn't choose a fund whose target date matches his retirement. What he really needs to know is how the fund plans to invest when he starts withdrawals.

Why? Because many funds continue along a so-called glidepath after their target date. Knowing that shareholders can live many more years, many funds don't reach their most conservative asset allocation until well after the target date.

That means Gunn should look for a fund whose asset mix five years after his retirement will suit his risk tolerance at that age and give him the level of growth he wants.

Stop Or Go

Janet Yang, an analyst for Morningstar Inc., said, "Funds fall into two groups: the ones that stop shifting their asset allocation at the target date and the ones that continue past the target date. See which group a fund falls into at its Web site."

A fund's mix of stocks and bonds before its target date also matters. Too much in stocks may lead to an overly volatile ride for some shareholders. Those asset mixes vary from one fund family to another.

Look for the asset breakdown in a fund's prospectus. If it isn't spelled out in enough detail, ask a phone representative for the fund.

Selecting a fund with a heavier stock weighting should be based on your stomach for volatility, life expectancy and income needs.

A fund with a heavy stock weighting and light bond weighting is designed for growth. It's designed to keep your nest egg growing faster than inflation.

That's a help if your withdrawals are a set portion of your balance, such as 4% annually.

Or do you want one built to generate income? Funds like that tend to do a better job of protecting principal in the short run, says Jerome Clark, who runs T. Rowe Price's 23 target-date funds.

If you want a TD fund that's built for growth, you'll likely want one whose rules give its manager leeway to try to take advantage of market surprises and opportunities, as well as to dodge oncoming freight trains in a sell-off, Clark says.

Again, check the fund's website and prospectus. Phone the fund if needed.

"Some funds' prospectuses limit how far a manager can go from specific asset weightings a manager," Clark said.

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.

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