News and analysis from Standard & Poor’s MarketScope Advisor
If the idea of a mutual fund is to make investing less work, target date mutual funds are a logical progression in their development. By shifting their asset allocations over time from aggressive, equity-weighted portfolios to a more conservative, fixed-income oriented posture, target date funds are meant to offer investors a type of “autopilot” on the way to their retirement, eliminating the need to manage the transition themselves.
Any ship’s captain will tell you, though, that while autopilot can certainly be a useful tool at sea, it is no substitute for genuine navigation, and it should not be relied on to steer the boat from port to port. So it is with target date funds.
Investors inclined to the “set-it-and-forget-it” approach need to understand first how target date funds function, make informed choices when buying them, and monitor performance along the way.
Target date funds, sometimes referred to as lifecycle funds, had amassed an impressive $176 billion in assets as of April, according to Investment Company Institute data. Almost all of that has come since 2006, when the Labor Department issued a rule exempting employers from liability for losses incurred by target date funds sold to retirement fund investors as a “default” option in their 401(k) plan. Fidelity, T. Rowe Price, and Vanguard are the largest target fund managers, with about 80% of the market.
About the only thing target date funds have in common is they assume that contributions will cease once the target date is reached. Most, though not all, are set up as “funds of funds” and invest in both equity and fixed-income instruments. Important features such as the size of their initial equity allocation, how quickly that is reduced, the size of the final equity allocation, and whether the manager has discretion to change the plan, all differ from fund to fund.
Furthermore, not all funds reach their most conservative allocation in the year they target: some funds don’t reach their most conservative stance for 20 years after the target date, believing that investors will need equity-style returns (read, normally higher than fixed-income) to fund retirement without running out of money.
SEC Questions on Returns