Target-Date Mutual Funds
There’s a new mutual fund on the block these days: the Target-date fund. It adds simplicity to investing. First, find the year closest to your retirement date. For example, if you are retiring in 10 years you might choose a Target 2015 or Target 2020 fund. Then put all of your retirement savings into that fund.
Simple? Yes. But isn’t that like putting all of your eggs in one basket? Not really.
Mutual funds invest in dozens, if not hundreds of securities. Most invest in a single asset-type, like stocks, bonds, real estate, or emerging markets. Asset Allocation funds diversify by adding other asset types such as foreign securities, real estate, commodities, and the like.
The problem with asset allocation funds is that while they are very much diversified across investments, they don’t change their risk profile across time. The fund manager is managing for thousands of investors who have hundreds of needs that are being satisfied by that single fund. Yet as you get toward and beyond retirement, you often want to reduce the risk in your portfolio. In other words, your needs change across time.
Enter the Target-date fund. The manager mixes up investments just like an Asset Allocation fund. But now the fund manager knows the approximate date that the investor is going to start using the money. So, as that target date gets closer, less of the portfolio is geared toward growth and more is invested for income.
With a Target-date fund, purports the mutual fund companies, you only need this one investment for your retirement savings…and for the rest of your life.
As you can guess, there are some problems with that. Yes, it changes across time, but it changes the same for everyone across time. That would be fine if everyone was the same, but there is a concept known as risk tolerance: the ability of an individual investor (you) to deal with the ups and downs of the market.
Let’s face it; one person will think that having 50% of their retirement savings in stocks is way too risky. A neighbor may think that the same 50% is too wimpy. The same thing happens with the mutual fund managers themselves. Looking at a recent report by Morningstar, I compared the Target-date funds from Fidelity, T. Rowe Price, and Vanguard, all well-known no-load mutual fund companies.
Examining the fund geared for year 2025, when I turn 68 (not that I’m planning on retiring then), I found the following. Stocks ran from 69% to 81%, Bonds from 15% to 21%, Small-caps from 6% to 9%. One had almost no money in Europe; the other two both had over 15% of their money there. One held 80% of bonds in AAA rated securities. The others held only 49% or 55% of theirs, putting more money into riskier bonds.
All three of the funds I examined target the exact same date, but they have very different ideas on how to get there.
Target-date funds are a great tool for a number of investors. But with this supposedly one-stop shopping, you still need to do your homework to see which tool works best for building your retirement savings.
Gary Silverman, CFP® is the owner of Personal Money Planning, a financial planning and investment management firm located in Wichita Falls. You may e-mail him at Gary@PersonalMoneyPlanning.com This article was published in the Times Record News, Sunday, August 17, 2008.
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