| In today's economic environment, everyone is | | | | composition of any Fidelity, Vanguard, or T-Row |
| looking for a better and easier way to save for | | | | Price target date funds, they all invest in their |
| retirement; with no shortage of people on Wall | | | | own mutual funds. These mutual fund companies |
| Street eager to develop new financial products to | | | | cannot possibly have the best stock and bond |
| help consumers find those ways, target-date | | | | mutual funds in every category. This approach |
| funds are the latest inventions that have become | | | | also creates overlap because fund managers of |
| all the rage. Though target date funds are not | | | | the same mutual fund company tend to invest in |
| new, their recent growth in investor appeal is | | | | the same investments which lead to the investor |
| cause for greater scrutiny. At face value, they | | | | being charged twice for holding the same |
| offer an easy way to save for retirement | | | | investment. While target-date funds that employ |
| without a lot of effort. The idea is simple enough; | | | | direct investing do not encounter this issue, these |
| investors put money into a fund that closely | | | | funds are the exception and not the norm. |
| matches their retirement date; the fund starts | | | | Apples to Oranges |
| off aggressive and gradually becomes more | | | | As with any investment, it is important to |
| conservative as the investor nears retirement | | | | compare performance against a benchmark. For |
| age. This decision seems like a no-brainer to many | | | | instance, someone invested in a large cap blend |
| who want to put their investments on auto-pilot. | | | | fund would compare its performance to the S&P |
| Unfortunately, target date funds are not suitable | | | | 500. Target date funds are nearly impossible to |
| for everyone. | | | | compare to a benchmark or to one another |
| Risk Tolerance | | | | because they do not neatly fall into any specific |
| The main disadvantage to target-date funds is | | | | category. Fund managers have tremendous |
| that they assume everyone has the same risk | | | | leeway in how they allocate their fund's assets, |
| tolerance. Risk tolerance is a combination of an | | | | and these ratios can change at any given time at |
| individual's ability and willingness to take risk. One's | | | | the discretion of the manager. As a result, two |
| ability to take risk is driven primarily by their | | | | different target-date funds with the same target |
| wealth. A person with $100 million who spends | | | | date may have vastly different allocations on any |
| $100,000 a year clearly has a high ability to take | | | | given day, which makes benchmarking even more |
| risk. Willingness to take risk, however, is very | | | | difficult. According to Morningstar, target-date |
| subjective. That same person may be less inclined | | | | funds with a 2010 retirement date have stock |
| to take risk if they have previously lost money in | | | | allocations of anywhere from 9.15 percent (DWS |
| the market. For this reason, the same fund may | | | | Target 2010 fund) to 65 percent |
| not be suitable for two different people who may | | | | (AllianceBernstein 2010 Retirement Strategy). And |
| be planning to retire in the same year and who | | | | while common sense would lead us to believe that |
| may have conflicting risk tolerances. Proponents | | | | a 2010 target date fund should be fairly |
| of these kinds of funds recommend adjusting the | | | | conservative because its investors are close to |
| target date to bypass this shortcoming. For | | | | retirement, the range of losses among funds is |
| instance, a more risk-averse investor would | | | | sizable. The DWS Target 2010 fund lost 3.6 |
| purchase an earlier target date fund (because the | | | | percent in 2008 while the Oppenheimer Transition |
| fund will become conservative sooner) while the | | | | 2010 N fund lost a staggering 41.5 percent in the |
| risk seeking investor would purchase a later | | | | same period. According to a recent Wall Street |
| target date fund. The problem with this approach | | | | Journal article date June 19, 2009, Morningstar |
| is that choosing an earlier target date does not | | | | found that funds with target dates between 2011 |
| always ensure less risk (see apples to oranges | | | | and 2015 lost 28 percent. There is no shortage of |
| below). | | | | articles written about the poor performance of |
| Best in Class | | | | target-date funds for people close to or near |
| No mutual fund company is an expert in | | | | retirement. |
| everything, and sponsors of target date funds | | | | Bottom Line |
| are no exception. Target date funds diversify | | | | Individuals interested in saving for retirement |
| their holdings into stocks, bonds, and cash by | | | | should develop an asset allocation that is |
| acting as either a fund of funds manager or direct | | | | appropriate for their objectives and their risk |
| investing. Fund of funds managers diversify their | | | | tolerance. No one should begin retirement |
| holdings among stocks, bonds, and cash by | | | | assuming their portfolio is safe, only to find out |
| investing in several other mutual funds to minimize | | | | later that their assets were in invested risky |
| risk. Target date funds that employ a fund of | | | | funds and they have lost 20 percent. Investors |
| funds approach usually invest in their own family | | | | shouldn't have their retirement savings exposed |
| of funds. For example, if you look at the | | | | to undue risk so close to retirement. |