Make a Date With Target-Date Funds Before And During Retirement

Target-date funds can be used by investors both before and during retirement. These funds rebalance the percentage of bonds versus stocks in the fund as the target date of the funds gets closer.

Target-date funds were designed for those who’d like someone else to do the heavy lifting. They’re also known as target-maturity, life-cycle, or target-retirement funds, and they’re promoted for retirees, young adults in their first jobs . . . and every other demographic group in between.

Mutual fund companies aren’t the only ones enthused about target-date funds. Not long ago, Congress lent its seal of approval by sanctioning their widespread use in 401(k) lineups.

There’s nothing magical about target-date funds. They can be a welcome tool for anyone who thinks that investing is tedious or beyond comprehension. (But even target-date funds require that you at least skim through the owner’s manual.)

You and your target-date fund are supposed to grow old together: As you age, your fund slowly turns gray by growing more conservative as you head toward retirement.

The fund’s manager takes care of the underlying investing mechanics. You just need to select a fund that closely matches the rough date of your anticipated retirement. If you’re planning on retiring in 2011, you could choose the Vanguard Target Retirement 2010 fund, or even the Vanguard Target Retirement 2015 fund.

A target-date fund serves as an umbrella, which contains a collection of underlying mutual funds or exchange-traded funds that invest in a variety of assets: blue chips and small caps, foreign stocks, and bonds. As the years go by, bonds shove some of the stocks out of the portfolio, making it more conservative.

For example, the Vanguard Target Retirement 2015 fund held 37.3 percent in bonds recently, whereas the bond exposure was 46.3 percent for the more conservative Vanguard Target Retirement 2010 fund.

Thanks to action by Congress, target-date funds have become more popular as 401(k) investment choices. Employers are now more likely to use these autopilot funds as default choices when workers don’t check off an investment choice. Congress also gave the workplace a green light to use target-date funds when they automatically enroll employees in 401(k) plans.

If you’re invested in a target-based fund at your workplace, you may be inclined to keep it when you retire. Before you do that or hunt for a new one, make sure it fits your needs.

There are roughly three hundred target-date funds—and the number is growing. Plenty of them are dogs. You won’t necessarily know that by looking at performance figures because quite a few of them didn’t even exist three years ago. Focus on costs instead: According to a recent study, the annual expense ratio for target-date funds ranged from 0.21 percent up to 1.4 percent.

Choose the cheapest target-date fund. Your best bet is to stick with funds for which the underlying choices are low-cost index funds, like the Vanguard Target Retirement funds. They offer the lowest price tags.

High expenses can silently chew up your returns and your account balance, especially when compounded over time. Because the fees are sucked out automatically, investors typically never notice. That’s exactly what fund companies are counting on.

Beyond price, examine how target-date funds spread around their assets. On this issue, these funds are all over the board. A study conducted by Target Date Analytics examined target-date funds marketed to investors retiring in 2010 and determined that the stock allocation ranged from 20 to 70 percent. That’s a huge range!

The three dominant players in the target-date field—Vanguard, Fidelity, and T. Rowe Price—all offer retirees a good dose of stocks in their most conservative offerings.
There’s no need to bail from a fund after it reaches its target date; it will just continue to grow more conservative. Vanguard Target Retirement 2005 recently had 58 percent of its investment in bonds and the rest in stocks. In a few years, the fund will eventually arrive at a 70/30 split of bonds and stocks.

Target-date retirement funds can serve a dual purpose: They can help you reach your retirement goals, and they can be excellent investments during retirement.

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