Targeting Retirement

retireDo you own a target-date mutual fund in your 401(k) plan or Individual Retirement Account? If you do, you should understand how target-date funds work. And if you don’t own one now, you might want to consider adding one of these popular funds, which let the investment pros decide on the appropriate investment allocations based on your hoped-for retirement date.

You can find target-date funds at all the major mutual fund companies, including Vanguard, Fidelity, T. Rowe Price, American Century — and very likely in your company retirement plan.

The concept of target-date (sometimes called “lifecycle”) funds is to create different funds for different targeted retirement dates, such as 2020, 2025, 2030 or beyond. You pick the fund that most closely matches the date you hope you’ll retire. Then you stick with the fund — and keep adding to it on a regular basis — over the years.

Each target-date fund gives the investor a different mix of various stock categories, along with bonds, and even more conservative money markets. Recognizing that unsophisticated investors get nervous about changing their allocations, these funds are managed to become more conservative in their allocations to stock as they approach the target date, the date you’ve set for retirement.

Even at the actual target date, these funds maintain some exposure to stocks — because they are designed for you to take withdrawals over your period of retirement. So you still need some — although a smaller amount — of the growth that stocks provide.

Target-date funds have become one of the fastest growing categories of mutual funds, since they were introduced about a decade ago. There is now more than $250 billion invested in them, with about 80 percent of those dollars invested through employer-sponsored retirement plans.

The big growth in target date funds came after the Labor Department ruled that companies could, and in fact should, default new employee contributions into these diversified mutual funds. They became a “safe harbor” option because these plans are designed to give investors managed exposure to the stock market.

Before target date funds received this “seal of approval,” many employees were defaulted into safer money market funds or the equivalent. While those funds guarded against loss of principal, they failed to give the employees a chance to grow their money over the long run for retirement.

After the huge market decline in 2008, many retirement plan investors were shocked that their target-date funds showed huge losses. They shouldn’t have been — if they had read the information that described how the funds work. After all, when the market has that kind of huge decline, all stocks will fall to some degree.

The entire idea of a target-date fund is that you’ll ride it out — not only to the targeted date, such as 2020, or 2025, or 2030 — but even beyond during your retirement years as you take withdrawals stretched out over your lifetime.

Sadly, those who mistakenly thought that target-date funds “guaranteed” a certain level of annual performance rushed to the exits at just the wrong time. Many sold out in shock just as the market reached its bottom in 2009. They missed the huge rebound.

So the big question has been: Do target-date fund investors really understand how these products work?

The Labor Department, which governs employee retirement plans, has proposed new disclosure rules and new education retirements so that unsophisticated investors would understand the risk of loss.

Now a new Vanguard study gives convincing evidence that these proposals may be unnecessary. (Vanguard-administered retirement plans are a leader in providing target-date funds for 401(k) and 403(b) plans.)

Their new survey reveals that people who actually choose a target-date fund for their own IRA have a better understanding of how these funds work than those employees who are just defaulted into a target-date plan. That’s not surprising, because investors who are responsible for their own decisions tend to do more homework.

Vanguard estimates that half of the participants in target-date funds in 2009 were simply defaulted into them as part of their employee benefits program. Even so, according to this survey, the vast majority were aware that these investments are not guaranteed and do involve risk.

Nearly two-thirds understood the benefits of diversification — but that it does not guarantee against loss. And only 8 percent of participants had the incorrect belief that target-date funds were designed to provide a guaranteed income. Even fewer were so misinformed as to believe these funds become “risk free” at the target date.

Investing is always easy in hindsight. One thing is sure: If you don’t take some appropriate risk in your investments, over the long run, you will barely break even with inflation — and may come out behind, after taxes.

There are three ways to minimize risk in the stock market. The first is to diversify your investments. The second is to continue to contribute to those diversified investments, through the ups and downs of the markets. And the third is to take a long-term perspective.

Target-date funds are designed to do just that — grow your money in a diversified way, using the discipline of professional money management — over the long run. As an employee, all you have to do is keep your eye — and your money — on target! And that’s The Savage Truth.

Terry Savage is a registered investment adviser and is on the board of the Chicago Mercantile Exchange. She appears weekly on WMAQ-Channel 5’s 4:30 p.m. newscast, and can be reached at She is the author of the new book, “The New Savage Number: How Much Money Do You Really Need to Retire?”