Target Date Funds

08/05/2010 Share 0 comments

Anne Tergesen of the Wall Street Journal looks into Target Date Funds.

"Target date" funds aim to take the complexity out of investing for retirement. Target-date funds are designed for investors who hope to retire around a certain date—say, 2025—and don't want to fuss with changing their allocations of stocks, bonds and cash by themselves. Instead, the fund becomes more conservative as the retirement date nears. The funds are increasingly available in 401(k) retirement plans, thanks to a 2007 Department of Labor ruling that allowed employers to offer them as a default investment option. Combined with their ease of use, that has made target-date funds a hit with investors. According to the Investment Company Institute, a mutual-fund trade group, the funds held $256 billion at the end of 2009, almost 10 times the figure in 2003.

New data from investment-research firm Morningstar Inc., based on a methodology used by professional investors, shed light on these opaque portfolios.

Among the takeaways: Fees are the single biggest factor in predicting the performance of target-date funds, and portfolios stuffed with funds that passively track indexes tend to outperform those holding funds run by money managers.

Only seven of the 31 fund families Morningstar included in its analysis managed to beat the benchmark over the three years ended June 30. (Of those, two—the Vanguard Target Retirement and Wells Fargo Advantage Dow Jones Target series—exclusively use index funds. A third, the Invesco Balanced-Risk Retirement funds, has substantially changed its approach since November.)

Five of the six top performers—including Vanguard, Wells Fargo and JPMorgan's SmartRetirement funds—were helped by below-average fees.

"Our research has found consistently that cost is the most reliable predictor of future performance," says Laura Lutton, a Morningstar analyst who specializes in target-date funds. "Given that most investors are probably going to own these funds for decades, cost becomes even more important."

MyPlanIQ's view is that Target Date Funds do make it simpler but you lose transparency. If your target date funds underperform, you may not understand why. A well chosen ETF portfolio is likely to give you better returns at a lower cost with much more transparency.

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Tags: Retirement, 401K, IRA