Are Target Date Mutual Funds For You?

Over the last few years, target date mutual funds soared in popularity, especially among companies offering 401(k)s to their employees. Today, I’ll take a look at these funds and how they can impact your overall financial state.

Are Target Date Mutual Funds For You?

According to the New York Times, target date funds became popular among employers because Congress enabled them to choose them for employees who didn’t specify a selection for their 401(k) savings plans. The best online brokerages and mutual fund companies promoted them as good choices because their funds are supposed to automatically move from higher-risk investments like technology stocks to more conservative ones such as bonds.

Such funds sound like steady choices for consumers, but when the market turns volatile just as it did last year, investors can still lose money. Since companies were allowed to automatically enroll their employees who didn’t make choices, those employees may have taken heavy losses during the stock market downturn.

The Times article cites losses as high as 40% for some 2010-dated funds and lists concerns that employees might not have understood that the funds weren’t guaranteed to produce income. According to Forbes, the poor performances of 2010 target date funds may bring about new regulations in the industry.

2010 and Beyond

Although 2008 may have resulted in losses for many of the 2010 target date mutual funds, this year’s outlook is more positive, according to the Wall Street Journal. If all the 2010 and 2011 funds look too conservative to you, then you might want to select a time frame in the next decade or two, or a period closer to your retirement date.

I don’t plan to retire for decades, so I’m amenable to having a higher percentage of stocks in my portfolio, but as I haul into the last decade of my work life, I’ll expect to see more bonds in there. I’m planning to open an account with a top discount brokerage and invest in several target date mutual funds: a 2050 fund for long-term growth as well as a 2020 fund.

Features of Target Date Funds

What should investors expect when looking for a target date mutual fund? Some factors are low fees, a range of investments, and how the fund handles its glide path, according to another New York Times article. The glide path is the rate at which a fund becomes more conservative; a 1% per year glide path is less apt to be disruptive than big changes every decade or so. Keeping fees low is important because no one wants their investments to be eaten up by growing costs.

As an example, take a look at the Fidelity Freedom 2050 Fund. Its year-to-date performance was 29.55% in mid-October 2009, with assets in equity, fixed-income, and short-term funds. The minimum to invest is $2,500 and there are no online transaction fees. Its expense ratio is .82%.

MSN Money has a chart listing the top funds with a target date of 2026 to 2030. One fund on the list is the T. Rowe Price Retirement 2030 Fund. Early on, it’s weighted 90% towards stocks and 10% bonds. Later, it’s slated to allocate more towards bonds.

The Target Date Mutual Fund That Works For You

While it’s tempting to let a target date fund manager do all the asset allocation or virtually all the work for me, others might prefer a more active role in overseeing their investments. The range of stocks, bonds, and other investment vehicles might not be to your liking, either. If you prefer to go your own way, you can try to create your own target date mutual fund by way of developing your own asset allocation model.

Essentially, you’d pick a target date, decide on your asset allocations and asset classes, invest in low- or no-cost bond and stock mutual funds, and rebalance once a year. Every few years, you should check up on your asset allocations and adjust your investments, or as needed. Although this strategy does require more legwork, the idea of managing your money this proactively is probably worth the outcome.

Before you sign up with a target date mutual fund, go over the prospectus carefully and do some research. Do stocks, bonds, and other investment vehicles appeal to you? What about the fund managers?

If you already have a target date mutual fund, keep tabs on it to see if you need to make any adjustments to your investments. Too much risk when you’re close to retirement can end up costing you, so don’t be afraid to change things, especially if your employer has already signed you up for your target date mutual fund.

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