Tips for choosing the right target-date fund

The performance of stocks in October ? their best month in almost a decade ? makes it tempting to peek at your 401(k) balance. Although October boosted the Standard & Poor’s 500 by 10.8 percent, it’s coming off of a disappointing third quarter when the index fell about 14 percent.

Investors in target-date mutual funds hoped their mix of stocks and bonds would help them avoid the severe volatility. Instead they’re likely to be disappointed as their funds fell sharply during the quarter.

Target-date funds automatically set the mix of stocks and bonds according to a worker’s risk tolerance and years until retirement.

A primary goal of target-date funds is to minimize the risk of steep market losses for investors as they get older and have less time to recover.


After the 2008 market downturn, target-date funds were heavily criticized because many of the funds were still heavily invested in stocks even though workers were within a couple of years of retirement.

The average fund with a 2010 target date for retirement lost about 25 percent in 2008. That led to government hearings and significant discussion about whether the funds were properly managed.

The criticism has changed many funds and they’re now more conservative in their investment approach, said Brooks Herman, head of research for BrightScope Inc., a provider of investment research and financial data, which recently completed a study of the funds.


The European debt crisis caused stock markets around the world to tumble in the third quarter. That hit companies of all sizes and sectors, and in turn mutual fund results. Target-date funds were no exception.

After finishing the second quarter slightly positive, the average target-date fund fell sharply with a nearly 12 percent loss during the quarter, said analysts at Ibbotson Associates, a subsidiary of Morningstar Inc. They track more than 380 target-date funds with at least a one-year track record.

Over the past 12 months target-date funds fell 1.4 percent on average. It was a reality check that these funds, often viewed by investors as options to help preserve capital, are not immune to market swings.


Target-date funds are often promoted as a set-it-and-forget-it retirement savings option. Employers typically choose a group of funds from a provider such as Fidelity or Vanguard, and workers choose a fund near their planned retirement year. There isn’t a lot a worker can control.

The biggest decision is whether to place the 401(k) money in a target-date fund or choose from a selection of individual stock and bond funds or cash investments to build one’s own portfolio.

“By and large a target fund is probably the most appropriate investment inside of a 401(k) lineup for most investors,” said Tom Idzorek, chief investment officer for Morningstar. That’s because putting together an equally diversified portfolio, following the investments, and rebalancing takes time, investment knowledge and, for most workers, some professional advice.

For those who decide to go the target-date fund route, here are a few tips:

? Be sure the fund’s schedule of easing out of stocks and more heavily into bonds, lines up with your personal risk level and retirement expectations. This schedule is what fund companies refer to as a fund’s glide path. You might feel like being a little more aggressive or more conservative than the predetermined path of the fund. There’s nothing wrong with investors who plan on retiring in 2030 choosing a fund with a target date of 2020, which likely would be more fully invested in bonds than a 2030 fund; or selecting a 2040 fund, which would remain invested in stocks longer. Also check the target-date fund investments occasionally because fund managers can change the planned mix.

The Department of Labor has published an investor bulletin on target-date funds, which goes over many of the basics. It’s available at:

? Because target-date funds are usually a managed collection of underlying funds, they can carry layers of fees. This means that it’s important to review the costs.

Look at the expense ratio. Although target-date funds have come down in price many critics still believe they cost too much.

The Ibbotson study shows that the average target funds had an expense ratio of 0.89 percent. BrightScope’s research shows an average of around 0.75 percent.

By comparison, average costs paid by 401(k) investors on their stock mutual funds dropped to 0.71 percent last year from 0.74 percent in 2009. Bond fund fees were at 0.56 percent in 2010 and 2009, said the Investment Company Institute, a trade group.

Target-date expenses can range from around 0.18 percent on the low end to more than 1 percent, so it pays to look closely.

Herman said target-date fees are coming down, the result of intense competition among providers.

Companies like Fidelity and TIAA/CREF are now offering funds with costs near Vanguard’s, which range from 0.16 to 0.19 percent. Others are likely to follow. The lower fees are accomplished largely by using index funds as the underlying investments.

? Check the managers of the target-date fund and those of the underlying funds. Are they experienced? Have they been with the fund for years? Morningstar recently downgraded a couple of target-date funds because of frequent changes in management and the lack of a clear, long-term succession plan.

Target-date funds have proven very popular. As of June 30, they held $382 billion, more than double the $160 billion at the end of 2008. They now hold about 10 percent of the invested assets in retirement plans and that’s expected to continue to grow rapidly as more companies now automatically enroll new employees into target-date funds.