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Is Your Target-Date Fund Suffering?

NEW YORK (TheStreet) -- During the volatile markets of recent months, many target-date funds delivered disappointing results. When the S&P 500 dropped 13.9% in the third quarter, Goldman Sachs Retirement Strategy 2040 (GRNAX) lost 17.7%, while DWS LifeCompass 2040 (TGTAX) declined 17.0%, according to Morningstar. The showing was especially painful because target-date funds are supposed to protect assets in downturns by holding diversified mixes of stocks and bonds. But not all target-date funds trailed the S&P 500. During the quarter, Invesco Balanced-Risk Retirement 2040 (TNDAX) returned 2.3%, while PIMCO RealRetirement 2040 (POFAX) lost 9.7%.

The divergent returns should serve as a reminder that target-date funds vary considerably. Although the funds all aim to serve retirement savers, some portfolio managers take significant risk, while others maintain a cautious stance. Riskier funds suffered the biggest losses in the downturns.

Despite the recent setbacks, target-date funds have remained popular choices for 401(k) plans and other retirement vehicles. According to Ibbotson Associates, there are 383 target funds with $345 billion in assets.

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The funds are designed to be convenient solutions for savers who will retire in certain years such as 2020 or 2040. Funds designed for people who will retire in 2040 or 2050 start with big allocations of stocks. As the retirement date approaches, the portfolios gradually become more cautious, increasing their allocations to bonds. The thinking is that retirees must be careful because they do not have time to recover from temporary market downturns.

While portfolio managers agree about the need to gradually reduce risk, funds follow a range of strategies. Some managers argue that investors should have big allocations to stocks in order to support long retirements. At the aggressive end of the spectrum is Goldman Sachs Retirement 2040, which has 85% of assets in stocks. The big stock allocation hurt the fund during the downturn of the third quarter. But in a bull market, the Goldman Sachs fund could lead the pack. A more cautious choice is Fidelity Freedom 2040 (FFFFX), which has 71% of assets in stocks.

Concerned about the threat of inflation, some funds hold a variety of different investments. Invesco Balanced-Risk Retirement 2020 (AFTAX) has a big stake in commodities, which can rise along with inflation. Fidelity Freedom 2020 (FFFDX) holds inflation-protected bonds.

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