Scoping Out Target-Date Funds

Choosing the right investment strategy for retirement can be daunting, and some investors turn to target-date funds to automatically manage their long-term savings.

If your employer offers a 401(k) savings plan, you'll need to consider: What's the best mix of stocks and bonds? What risks am I willing to take? Do I want to manage my portfolio or have a professional do it?

Some people don't have the time or knowledge to actively manage their retirement funds--and that's where target-date funds come into play.

Target-date funds, sometimes called lifecycle funds, are an option in many employee-sponsored 401(k) plans. The advantage is that these funds take the tough choices out of an investor's hands and automatically balance your accounts to minimize risk as you approach retirement.  

"It requires very little ongoing management," says Ryan Alfred, president of BrightScope, an independent firm that rates 401(k) plans. "Investors can put money in the fund and let it run 'til retirement."

How Target-Date Funds Work
Companies offer target-date funds as an investing option for employees enrolled in 401(k) plans. Target-date funds are made up of a combination of cash, bonds and stocks--in many cases a mix of domestic and foreign stocks, according to BankRate.com.

For workers in their 20s or 30s, the plans are designed to put the majority of assets into more aggressive investments such as stocks--which have higher risks and higher rewards--because younger investors have more time to make up any losses. As an investor ages, target-date funds gradually reallocate the mix of assets into safer investments, such as bonds, for retirement.

The funds are selected with your retirement age in mind. A person who is 40 years old in 2010 and plans on retiring at age 65 would invest in a 2035 target-date fund because 2035 represents their expected retirement year.

Are They for Everyone?
The decision about whether to choose a target-date fund depends on an individual investor's circumstances and financial savvy. Investors who want to actively manage their funds might want to look elsewhere, but target-date funds are ideal for those who don't want to have to deal with investment choices.

"It's really a matter of how much involvement they want to have when managing investments," says Josh Charlson, an analyst with Morningstar, a Chicago-based investment research firm.

One of the main drawbacks to target-date funds are annual fees. Target-date funds are 10 to 25 percent more expensive than other core funds in retirement plans, according to an October 2009 analysis of retirement plans by BrightScope. The majority of the target-date funds have an annual management fee of 1 percent or more, according to Morningstar. One percent might not seem like much, but over 30 years it can add up.

The least-expensive target-date fund series is Vanguard Target Retirement with an annual fee of 0.19 percent, while the most expensive target-date fund series is Oppenheimer LifeCycle Series, with annual fees of 1.71 percent, according to BrightScope's Alfred.   

Glide Path
Target-date funds are designed with a "glide path" investment strategy that gets more conservative as the fund ages. There is, however, a wide range in how conservative the funds actually get.

"Investors need to understand their fund's glide path and make sure they are taking on the right level of risk as they approach retirement," says Alfred. "Many of these funds aren't nearly as safe as investors assume."

For more information on target-date funds, visit Bankrate.com or SmartMoney.com.