By Lynn Brenner
NEW YORK, June 27 (Reuters) - 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,” Ameriks says.
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 to retire.
2. Is the fund intended as a ‘to’ retirement or ‘through’ retirement investment?
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 target date.
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.