The right target-date fund for you

Target-date funds have become tremendously popular as investors seek to simplify their retirement planning. An investor picks the year in which he/she plans to retire — or the year in which he expects to start withdrawing money from his retirement fund. The appropriate fund will shift its asset mix to become increasingly conservative as that date approaches.

Investors can choose from more than 285 target-date funds, which hold a total of more than $180 billion in assets, compared with only 31 funds and $7.8 billion in assets seven years ago. And their popularity will continue to soar now that the US Department of Labor has deemed the investment category an “appropriate” default option for employers who automatically enroll employees in a 401(k) plan.

Choosing the best fund for your goals and risk tolerance can be trickier than it seems. We asked employee benefits specialist Joe Nagengast to explain what you need to know.

HOW THEY DIFFER

Typically, target-date funds invest in a variety of stock and bond mutual funds offered by the same fund company, creating a diverse mix of investments. Sometimes the mix includes stellar funds that are closed to new investors for direct investments. How to choose the right fund for you…

  • Make sure the target-date fund’s investment mix fits your risk tolerance. Different funds with the same target retirement date may allocate their assets in very different mixes of investment types, creating very different risk levels. The more aggressive target-date funds tend to have the potential for greater gains or losses. For example, in the equity portion of their target-date portfolios, Putnam, State Farm and T. Rowe Price tend to hold more small- and mid-cap stocks, which are typically more volatile. Fidelity, Vanguard and Wells Fargo tend to emphasize large-cap stocks, which are generally more stable. If you have trouble gauging your risk tolerance, speak with a financial adviser.
  • Understand the fund’s “glide path.” How rapidly the fund changes its mix of stocks, bonds, money-market investments and other assets as its target date grows nearer can vary significantly among competing target-date funds.
  • Important: At most financial institutions, the glide path continues after a fund reaches its target date. That’s based on the assumption that the fund investor won’t cash out all assets at one time upon reaching the target date. How quickly the fund reaches the end point varies. For instance, T. Rowe Price Retirement 2020 Fund doesn’t reach its final conservative allocation until 2050 — 30 years after the target date. In comparison, Vanguard funds reach their final allocations approximately seven years after the target date.

  • Avoid hefty annual fees. Fund expenses add up over long periods. Your target-date fund should reflect an average of the fees of the underlying funds, without adding an extra layer. In general, don’t choose a target-date fund that charges more than a 0.8% annual expense ratio.
  • Choose a target date that corresponds to your plans and needs, not just your age or retirement date. For instance, most people in their early to mid-50s who are planning to work for another 10 to 15 years would select a 2020 fund. But if you have a pension or other big source of income that you plan to draw on first, you might choose a 2025 or 2030 fund. Reason: You have an unusually long time until you plan to start drawing on the assets, so you can afford to go with a more aggressive fund.
  • Or you may want to split the difference and buy more than one target-date fund. Suppose you plan to retire in 2017. You could purchase a mix of, say, Schwab Target 2010 and Schwab Target 2020 because you will be drawing on the investments over many years and don’t want all of the assets shifting to a very conservative mix at the same time.

    To compare 100 target-date funds: Go to the free Web site that I help manage for Target Date Analytics at www.tdbench.com. For analyses of individual funds, go to www.morningstar.com or http://finance.yahoo.com.

    AN INSIDE LOOK AT THREE POPULAR CHOICES

    To demonstrate how target-date funds differ, here are three popular 2020 target-date funds appropriate for an investor in his/her 50s saving for retirement. Each fund company also offers other versions with similar strategies but different time lines and target dates…

  • Fidelity Freedom 2020 (FFFDX). Best for: Investors who want broad diversification and a deep reduction of stocks after the target date. It consists of 25 underlying Fidelity funds. Glide path: Moderate. The fund will gradually reduce its equity holdings over the 12 years leading to its target date to 50% of the portfolio. After that, the stock allocation drops for another 15 years down to 20%. Expense ratio: 0.76. 800-544-9797, www.fidelity.com.
  • T. Rowe Price Retirement 2020 (TRRBX). Best for: Investors who want a higher allocation of stocks at the target date. Underlying funds include several of T. Rowe Price’s best offerings, some of which are otherwise closed to new investors. Glide path: Aggressive. When the fund reaches its retirement target date, it still maintains 60% in stocks. After that, it reduces equities very slowly over the next 30 years to a final stock allocation of 20%. Expense ratio: 0.69. 800-492-7670, www.troweprice.com.
  • Vanguard Target Retirement 2020 (VTWNX). Best for: Investors who want the low expenses of index investing. Its underlying funds include five to seven index funds, which means they track an index rather than depend on a manager to actively choose stocks. This helps make the fund, which launched in June 2006, among the least expensive of all target-date fund choices. Glide path: Moderate. In the years leading up to the target date, stocks are gradually reduced to 50% of the portfolio. For the next seven years, the equity portion declines more rapidly to a final allocation of 30% stocks. Expense ratio: 0.2. 800-523-7731, www.vanguard.com.
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