Net Gains: Hands-Free Investing Through Target Funds

Jan. 2, 2008 — -- The investment world can't seem to make up its mind about target-date mutual funds.

Some studies say they are too conservative and will not provide the returns future retirees need to finance their golden years. Others say these all-in-one funds are too aggressive, delivering too much volatility in the crucial years just before retirement.

And still other studies warn too many target-date funds charge excessive fees that act as a drag on investor returns. This one I believe, but that's not unique to target-date funds. The wise investor must always be aware of outrageous costs in nearly every type of investment vehicle.

From where I sit, the target-date mutual fund is a much-needed investment option for millions of workers whose only retirement plan is a 401(k) or other similarly defined contribution plan. These workers are responsible for all investment decisions even though many lack the knowledge or interest to build a retirement portfolio.

For them a target date fund may be the perfect solution.

A target-date fund is a mutual fund constructed with a particular retirement year in mind. That retirement year is the target date and usually indicated in the fund's name. For instance, a 2030 fund is intended for somebody like me who is due to turn 65 in or around the year 2030. A 2010 fund is meant for somebody 20 years older than me; a 2050 fund for somebody 20 years younger.

Target-date funds hold a diversified mix of stocks, bonds cash and possibly other investments, allocated in a way appropriate for the intended age group. For the youngest workers, target-date funds start out invested almost exclusively in stocks -- both domestic and international. Over time, as the target date approaches, the investment mix shifts to a more conservative one, shedding stocks little by little and picking up more bonds and cash.

Typically, they are offered in employer-sponsored retirement plans, but can be purchased by individuals, most often in an IRA.

In most cases, target-date funds are made up of various individual funds operated by the mutual-fund family that sets them up. For instance, Fidelity's Freedom Funds own only other Fidelity funds, and T. Rowe Price's Retirement Funds own strictly other T. Rowe Price funds.