By Lynn Brenner
NEW YORK, June 27 There's nearly $400 billion
and growing invested in target-date funds, but these
one-size-fits-all funds are neither as safe nor as simple as
most people believe.
A recent Securities and Exchange Commission survey (see
"Investor Testing of Target Date Retirement Fund Comprehension
and Communications" at) reveals
that 54 percent of investors don't realize that funds bearing
the same target date, but offered by different companies, don't
have the same asset mix. In reality, the allocations and risk
levels of funds with identical dates can differ dramatically. In
addition, the SEC found that only 36 percent of the investors
surveyed understand that target-date funds do not provide
guaranteed income in retirement.
Introduced 17 years ago, target-date funds are now America's
best-selling retirement investment, thanks to their enormous
popularity in 401(k) plans and Individual Retirement Accounts.
Their assets have more than tripled since the end of 2006, from
$108.3 billion to $384 billion, according to Lipper, a Thomson
Reuters company. The funds are designed for people who'll retire
at 65 in the target year, and each fund's asset mix
automatically gets more conservative over time. Picking the
right one looks as simple as choosing your retirement date.
But although a target-date fund can be a good choice if
you're not a hands-on investor, you'd better look under the hood
before you buy one. Here are six key questions you should ask.
1. What's the 'glide path'?
The glide path is the predetermined schedule by which the
fund's stock exposure will decline over time, making it less
vulnerable to short-term market fluctuations. There's no
consensus about what constitutes an age-appropriate asset mix,
and glide paths range from conservative to aggressive. For
example, the stock allocation of 2015 funds - intended for 62
year-olds three years from retirement - ranges from 20 percent
to 78 percent of the portfolio, according to Morningstar.
Don't assess the fund's risk level in isolation, says John
Ameriks, a principal at Vanguard. "You really need to look at
the risk level of your total retirement portfolio. For most
people, a 401(k) and IRAs are complementary to Social Security,"
Consider your personal situation as well as your retirement
date. A tenured professor probably can afford a more aggressive
glide path than a stock broker, for example, because he's less
likely to be laid off and forced to tap his account early. In a
401(k) plan, where you're limited to the target-date funds of
one provider, you can get a more conservative glide path by
picking a fund with a date a few years earlier than you intend
2. Is the fund intended as a 'to' retirement or 'through'
Investors were shocked when 2010 funds sustained big losses
in the market melt down three years ago: They assumed funds
intended for people on the verge of retirement would be
insulated against short-term losses.
Indeed, the SEC survey found that most people believe a
fund's portfolio is frozen at its most conservative allocation
at the target date. But many target-date funds - including those
of Fidelity, Vanguard and T. Rowe Price, which account
for more than 75 percent of all target-date fund assets - are
designed to make your nest egg last as long as you do. They
don't reach their most conservative mix until years after the
Vanguard and Fidelity's funds, respectively, aren't at their
most conservative until seven and fifteen years after their
target dates. T. Rowe Price's keep evolving for 30 years.
"We assume you'll be taking withdrawals from your portfolio
until age 95," says Stuart Ritter, a financial planner at T.
Rowe Price. "You won't use some of your money for 15, 20, 25
years. Investing in equities is the best way to keep up with
inflation - and at 3 percent annual inflation, the cost of
living will double over 20 years."
3. How much is the fund manager allowed to deviate from the
predetermined glide path?
Check the prospectus. A 'tactical' asset allocation strategy
means the managers can adjust the fund's asset mix in response
to short-term market conditions if they believe they can
sidestep losses or maximize returns by doing so. Be warned: An
aggressive 'tactical' strategy can be indistinguishable from
market-timing - the very antithesis of target-date investing.
4. What's in the portfolio?
In addition to traditional stocks, bonds, and cash, some
funds now hold Treasury inflation-protected securities (TIPS),
real estate, and commodities. Others use derivatives and
'absolute return' strategies. Allocations to non-traditional
assets can have a significant impact on a fund's risk profile,
notes Morningstar. Certainly, there's a case to be made for some
of these holdings, but you should hear it.
5. What does the fund cost?
Annual fees are the single biggest predictor of target date
fund performance, Morningstar says. On average, you pay $110 a
year per $10,000 invested. At the low end of the spectrum,
Vanguard charges $18 per $10,000 invested; at the high end,
Oppenheimer charges $131 per $10,000. Check for the cost in the
fund's prospectus, not in the annual report, says Tom Roseen,
senior analyst at Lipper. Annual reports typically list a fund's
'wrap' fee but don't include the charge for underlying funds.
6. What's the fund company's reputation?
Since a target-date fund typically consists of underlying
funds from a single provider, you're really buying into the fund
family and its parent company. Target-date providers of actively
managed funds sometimes tuck a lemon into the package to get
assets into it, notes Roseen. Morningstar has target-date fund
rankings that rate the fund company's corporate culture, the
caliber of its portfolio managers and the quality of their
research, as well as funds' cost and performance.