Target-date retirement funds have shot up in popularity -– because they offer investing simplicity, perhaps, but also largely because recent pension-law changes allow employers to make them the default option in corporate 401(k) plans.
But before you buy one, take this 30-second test:
- In last year's horrendous bear market, the worst-performing target 2010 fund lost 41.5% of its value, while the best-performing target fund slipped only 3.6%.
- One of these funds is named DWS Target 2010. The other is Oppenheimer Transition 2010 N.
- Which was which?
The correct answer is that the DWS fund was the least awful.
But how could you have known that, and, in particular, how could you have known that in advance? Or how could you have predicted that Barclays Global Investors LP 2010 I (STLBX) would slide only 17.0%, while AllianceBernstein 2010 Retirement Strategy A (LTDAX) would plunge 32.9%?
You couldn't.
The funds are all aimed at the same group of investors: those planning to retire next year. But that's where the similarities end.
"They're like a bunch of chocolates -- you never know what you're going to get," says George Papadopoulos, a financial planner in Novi, Mich.
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Flying blind
The idea behind these "pick and forget" funds is simple: Choose a year based on when you plan to retire -- in 2010, 2015, 2020 and so on.The fund's holdings presumably become more conservative as retirement draws closer, to keep you safe. Although there's no guarantee, you're told you can expect a certain rate of return.
But the companies behind these target-date funds are free to follow any strategies they choose -- aggressive ones at Oppenheimer and AllianceBernstein, conservative ones at DWS, in between at Barclays -- and adopt any practices they want, leaving you, the investor, in control of nothing.
Fund investors elsewhere can mix value and growth, combine market sectors and make myriad other choices to balance their portfolios. With a target-date fund, you have to trust that it's being done for you. Even holding other funds violates the spirit of target dates.
In fact, the performance of target retirement funds in 2008 demonstrates how dangerous it can be to entrust your nest egg to a panel of supposed eggheads who could well turn out to be boneheads. Rather than letting it run on autopilot, you need close management of your retirement kitty so you can be sure it will meet your personal needs.
"I avoid target-date funds like the plague," says Robert Gerstemeier, the principal of his own firm in Naperville, Ill. "They are fraught with inconsistencies and lead individuals to make the wrong decisions."
Take a simple approach instead
You're better off executing a simple strategy of your own. And one of the most sensible pieces of investment advice I've ever gotten about retirement savings is this from Rick Rogers, a money manager in Lancaster, Pa.:Asset allocation should be based on income need, not financial theory. An investor who needs $40,000 in income from his investments should have "$40,000 times 10 years ($400,000) in bonds." Everything else should be in stocks. The bond allocation "would allow the client to ride out even a severe downturn in the stock market without jeopardizing his income."
You simply cannot get that kind of specificity with target retirement funds. They leave you flying blind.
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The truth about target-date fundsDan Wiener, the founder of The Independent Adviser for Vanguard Investors, a monthly newsletter, discusses whether you should consider target funds for your retirement account.
I've pointed out before that target-date funds vary widely, depending on the strategy of the sponsor and on the success of the strategy's implementation. In a column in September 2007, just before the bear market began, I put three of the biggest target-date funds under the lens: Fidelity Freedom 2010 (FFFCX), T. Rowe Price Retirement 2010 (TRRAX) and Vanguard Target Retirement 2010 (VTENX).
In that column, I noted that T. Rowe's fund was significantly more aggressive than the two others, at the time holding 62% of assets in stocks, compared with 54% for Vanguard and 53% for Fidelity. Bonds and cash accounted for correspondingly less of T. Rowe's assets.
Based on that analysis, it would be logical to expect that the T. Rowe fund would have done significantly worse than the other two in 2008, when the Standard & Poor's 500 Index ($INX) plunged 37%. But the 26.7% decline of that fund was not very different from the 25.3% loss at Fidelity. The Vanguard fund shed only 20.7% of its value, and that is a significant difference -- but it's just as significantly different from Fidelity's return as from T. Rowe's. There is no way you could have predicted the Fidelity-Vanguard difference in advance.
These kinds of disparities run rampant through the target retirement universe.
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