Regulators and investors have been lashing out at target-date funds.
At a recent hearing, Securities and Exchange Commission Chairman Mary Schapiro said investors had been surprised by big target-fund losses during the downturn of 2008. The damage was particularly painful because target-date funds had been billed as safe choices for retirement savers.
Some financial advisers have called for regulating the funds more closely or scrapping them altogether. But for the moment, millions of investors still have good reasons to use them. For starters, target funds are the best options available in many 401(k) plans. In addition, the funds offer a convenient way to obtain diversification.
Target funds are designed for investors who expect to retire around a certain date, such as 2010 or 2030. The idea is to provide a single investment that retirement savers can buy and hold for years.
A typical target portfolio keeps a diversified mix of stock and bond funds. As investors age and approach the retirement date, the portfolio allocation is automatically adjusted to be more conservative and hold increasing weightings of fixed income.
The funds aim to make investing simple. But as all the fuss suggests, shopping for a target-date fund is not easy. Before making any purchases, investors must weigh a blizzard of figures.
Data on returns can be especially misleading. Consider the returns of funds with maturity dates of 2015. At first glance, some funds appear superior to others. Near the top of the performance standings is
, which returned 3.2% annually during the three years ending in June, according to Morningstar. Lagging is
T. Rowe Price 2015
, which lost 3.3% during the period.
Though SunAmerica leads T. Rowe Price, investors should dig deeper before reaching any conclusions. The reality is that the two funds are very different creatures. SunAmerica has about 90% of its assets in bonds and cash, with 10% in stocks. T. Rowe Price only has 32% in fixed income. While the big fixed-income stake cushioned SunAmerica during the recent downturns, the fund is hardly suitable for shareholders who want to hold sizable equity positions in their retirement portfolios. Despite its problems during the bear market, T. Rowe Price is the better choice for investors who seek to emphasize stocks.
After spotting portfolios that have appropriate asset allocations, investors should continue investigating to evaluate the individual holdings of funds. Even funds with similar allocations can maintain very different portfolios. Compare
American Century Livestrong 2040
Fidelity Freedom 2040
Both funds have about 80% of assets in equities and the rest in fixed income. But the bond portfolios are very different. Fidelity has about 10% of its assets in two bond funds,
Fidelity Capital Income
Fidelity High Income
. Those funds hold high-yield bonds that are rated below investment grade. American Century takes a more cautious approach, putting about 4% of assets into
American Century Inflation Protection Bond
, a fund that owns high-quality securities. The target fund only puts 2% of its assets in a junk fund,
American Century High Yield
Both the Fidelity and American Century target funds can make sensible choices. But investors who worry about rising corporate bond defaults may feel more comfortable with American Century.
Besides analyzing individual holdings, investors must consider how target funds intend to evolve over the years. Each fund typically adopts a so-called glide path, a plan for how the asset allocation will shift as the saver approaches retirement. Some funds begin with aggressive equity allocations in their early years and then shift to cautious stances as the retirement date approaches.
A young person who buys
Vanguard Target Retirement 2050
will start with an aggressive stance, holding about 10% of assets in fixed income and the rest in equities. That is similar to the allocation of
Aim Independence 2050
, which has 9% of assets in fixed income. But the two funds have different glide paths. By the time retirement rolls around, the Vanguard investor would have around 47% of assets in fixed income, while the AIM shareholder would have a more cautious portfolio with 68% in fixed income.
Which fund is better for you? That can be difficult to determine. In an effort to help advisers and employers decide on the best choices, Morningstar is beginning to issue four-page reports on target-date funds. The length of the research is notable because Morningstar has long provided single-page reports on conventional mutual funds.
Investors seeking guidance from the Morningstar target-date reports must be prepared to plow through pages of charts and data. All the effort may be necessary to make an intelligent decision about these complicated investment choices.
Stan Luxenberg is a freelance writer who specializes in mutual funds and investing. He was formerly executive editor of Individual Investor magazine.