Robert Powell| Special to USA TODAY
Many people saving for retirement invest in a target-date fund or TDF.
This kind of investment is a fund of mutual funds that becomes more conservative as it nears its target date. It typically invests in a mix of stock, bond and money marketfunds, and its name usually ends with a year, like 2030 or 2050. An investor would use a target-date fund that best matches their anticipated year of retirement.
Here’s what you need to consider when evaluating and selecting a target-date fund:
The allocation shift
Target-date funds typically own more stock than bond funds when they're further away from the target date. But over time, the fund becomes less risky – reducingthe percentage invested in stock funds and increasingthe percentage invested in bond funds. That’s called the fund’s glide path.
Two items to note: Not all funds reduce the percentage invested in stock funds in the same manner. And there are two types of target-date funds: “to” target-date fundsthat reach their final allocation of stocks, bonds and cash at their target date, and “through” TDFs, whose allocationcontinues to adjust for a number of years beyond the date, according to Fidelity Investments.
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Bottom line: Make sure your tolerance for risk aligns with the TDF’s glide path and that you know whether you own a “to” or a “through” TDF.
Fees
The performance of target-date funds is becoming more alike, according to a Morningstar report. Given that trend, Morningstar suggests putting “a strong emphasis on fees when evaluating TDFs as fees are likely to become a bigger edge for the cheapest funds going forward.”
The average asset-weighted expense ratio was 0.66% at the end of 2017, according to this Morningstar report.
Others take a different view of fees. “Fees are a critically important part of any investment decision, but need to be considered as part of a complete strategy,” says Ed Murphy, president and CEO of Empower Retirement. “Knowing the price of something without understanding the value is meaningless.”
Saving enough?
Target-date funds don’t guarantee that investors will have sufficient savings for retirement, says Jeff Holt, the director of multi-asset and alternative strategies at Morningstar Research Services.
“While they provide a diversified portfolio that accounts for an investor’s age, investors still have the responsibility to save enough for retirement,’ he says. “Target-date funds don’t remedy a shortfall in savings, but they may provide investors with a diversified portfolio," throughouttheir career.
Underlying investments
The quality of underlying investments varies by target-date series, according to Morningstar's Holt. Funds typically offer investors a “series” of target-date funds from which to choose: 2020, 2025, 2030 for instance.
Considerwhether the majority of the funds in the target-date fund you are looking atare highly rated – Morningstar Medalists funds for instance.
“Investors need to evaluate if target-date managers use those building blocks effectively in creating a target-date series,”Holt says.
Asset class diversification
Generally, most target-date funds provide investors with exposure to broad asset classes, such as U.S. stocks, international stocksand bonds.
“However, the balance between these broad asset classes and the exposure to sub-asset classes such as U.S. small-cap stocks and high-yield bonds can differ significantly series to series, even for target-date series that appear to have similar equity glide paths,” Holt says.
Downside risk protection
Target-dates provide diversification, not capital preservation.
“While target-date funds have diversified portfolios, they are still exposed to market declines,” says Holt.At the target date, Holt says the funds still hold about 45% in stocks, on average.
Bottom line: Expect these funds to experience market declines to some extent. “For instance, in 2018, target-date funds lost more than 6% on average,” he says.
Performance
Investors should avoid jumping to conclusions – good or bad – about performance for target-date funds without putting it in proper context, says Holt. “The differences in approach to asset allocation between target-date series requires looking at performance from multiple angles,” he says.
Robert Powell is the editor of TheStreet’s Retirement Daily www.retirement.thestreet.com and contributes regularly to USA TODAY. Got questions about money? Email Bob at rpowell@allthingsretirement.com.
Target-date funds taking over employee retirement plans
Target-date funds are taking over 401(K) plans as employers increasingly make them the default option in retirement plans, said Jake Gilliam, Sr. Portfolio Manager for Charles Schwab Investment Management.
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