Are Target Date Funds your Retirement Solution?

Are Target Date Mutual Funds your 401k or IRA Answer?

The formula seems simple. Determine the year in which you want to retire and put a bull's-eye on the calendar. Go to your employer-sponsored 401(k) or IRA, or to your individual brokerage account, and find the "target date" mutual fund that matches your retirement date. Start pouring your retirement dollars into that one fund.

As the years go by, your fund is routinely rebalanced and becomes incrementally more conservative. The theory is that as your retirement date arrives, the changing asset mix will provide the proper recipe for stability and growth.

Target date funds can help eliminate the confusion many employees and investors feel when faced with too many mutual fund choices in the typical 401(k). Each fund is a mix of cash, bonds and stocks, including in many cases some foreign stocks. The fund's name includes the retirement year, and the funds are usually spaced five years apart (e.g., 2010, 2015, 2020, etc.).

Pros:

Bypass minimum investments - Most mutual funds have a minimum investment (usually a few grand) to buy into the fund. If you try to buy into various funds individually to create a well diversified portfolio, you will need a substantial amount of cash. For target date retirement funds, you only pay this minimum investment once.

Automatic investments - It doesn’t matter how much self control or investment knowledge you have. You automatically get a desireable asset allocation that shifts with time. Along with that desired asset allocation comes a certain amount of reassurance that you won’t lose your entire nest egg.

Cons:

Subpar performance - Investment firms will undoubtedly look out for their own interests. Therefore, firms like Vanguard or T Rowe Price will only include their companies funds (stock/bond/investment/emerging market) in their target retirement funds. Therefore, you may lose out on performance. Surely, that company does not have the best mutual funds in every single market.

Lack of control - The selling point of target date retirement funds is that you don’t have to own anything besides it. But at the same time, you shouldn’t own anything besides it (or you will throw off the asset allocation. That means apart from that one fund, you have zero control in your retirement assets.

Fees - This is the same argument between mutual funds vs index funds. Sure you’re paying someone to manage the fund, but can you get the same or better performance from owning the market (index fund)

Too often, employees don't use target date funds properly, and you have to wonder whether one fund can really be appropriate for everyone who retires in a given year.

Another potential problem is that employees aren't given enough information regarding the philosophy behind target date funds and how they should invest their money.

While that problem might be fixed by better educating employees and other investors who consider these funds, another situation might be more perplexing to consumers. The asset allocation in a specific target date fund can vary from one firm to another.

A recent analysis of target-date funds by consulting firm Watson Wyatt found that allocations to equities for employees 10 years from retirement varied from 40 percent to 80 percent among target-date funds in 2006. And equity allocations for employees on their retirement day ranged from 20 percent to 65 percent.

A Morningstar Direct report found that some funds for employees expecting to retire in 2010 still have almost 70 percent of assets in equities

As with any investment, target date mutual funds can be a good tool for some investors when planning for retirement. However, one must be very aware of the potential drawbacks associated with the funds. Bottom line: There is no cookie cutter approach for every investors needs.