Choosing a Target-Date Mutual Fund

Are All Target-Date Mutual Funds Created Equal?

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Target-date mutual funds were created more than 10 years ago and billed as a simple, one-size-fits-all investment solution. But is anything ever quite that easy? The simple answer, of course, is, “No.”

Why Own a Target-Date Mutual Fund?

If you plan to retire in 20 years, you might consider buying a target-date mutual fund that matches your time frame -- that is, a fund with a target of 20 years. As you approach your retirement date, the fund moves its allocation away from riskier, but often higher-rewarding mutual funds (with holdings like equities) to more conservative mutual fund investments (with holdings like bonds and cash).

The idea is to save you from having to ensure that your portfolio is re-allocated based on your changing needs: Let the fund do all the work.

The target-date mutual fund's re-allocation over a predetermined period to reflect investors’ changing tolerances for risk is known as the target-date fund’s "glide path." This glide path sets the fund’s allocation among various asset classes over time, adjusting the mix from more aggressive investments early in the life of the target-date fund to more conservative investments as the fund matures and investors approach their target retirement date goal.

Analyzing Target-Date Mutual Fund Options

If you are counting on target-date mutual funds as a simple solution to your retirement investments, be careful. Just as with any investment, you need to do some homework first. All target-date mutual funds are not all created equal.

Funds with identical target dates may have very different asset allocations.

For instance, the T. Rowe Price Retirement 2030 Fund has 66% invested in equities at the target date, while the Vanguard 2030 Retirement Fund has 50% invested in equities at the target date. While the two funds have the same target date, the asset allocation at the target date is drastically different.

You need to carefully determine your comfort level with the target-date fund's current asset allocation and be aware of the fund's higher/lower equity allocation at your target date. One size does not fit all.

When looking for the right target-date mutual fund for you, consider the following:

  • Asset allocation -- Look carefully at your target-date fund’s allocation between equities, bonds and cash, and examine how these holdings change as the fund moves closer to your target date and beyond. Remember that in the example described above, the allocation among various asset classes can be different from fund to fund.
  • Diversification -- Does the fund predominantly invest in US stock funds or is a portion invested in international stock funds, emerging market stock funds and hard asset funds? Does the target-date fund allocate a portion of your assets to Treasury Inflation-Protected securities or does it stick with plain vanilla bond funds.
  • Quality of Underlying Funds -- Look at the funds within the target-date fund. Are they mediocre, or do they have a reasonable track record when compared against their peers?
  • Fund Families -- Does your target-date fund invest in funds outside of the fund's fund family? In other words, if you buy a target-date fund from Fidelity, does it only invest in Fidelity funds or does it look to other fund families to manage a portion of the fund? Often times, one fund family specializes in one particular investment style (equities for example) while another fund family may specialize in another investment sytle (bonds for example).
  • Expenses -- As with any investment, costs should always be a consideration. Is your target-date fund a no-load fund, or is there a front-end or back-end load associated with the fund? How does the expense ratio of the fund compare with other target-date funds? While it's never a good idea to simply purchase a fund because it has the lowest cost structure, your target-date fund's costs should be carefully weighed along with the benefits.

Unfortunately, there is not a simple solution to choosing the right target-date fund. Like any proper investment, you must do your homework by researching and understanding the asset allocation, diversification, underlying funds, and cost structure. A little research, will put you a long way toward finding the right fund for you.