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Mutual Funds

Target Funds Get Hit, Too

The market collapse has coincided with an uptick of workers who are relying on these single-fund solutions.

Investors expecting just a bit of solace from their target-date retirement funds have been sorely disappointed, and perhaps disillusioned. The variety of investments in these all-in-one funds was supposed to cushion against downturns. And weren't target-date funds supposed to be less volatile than other investments?

The market collapse coincides with an uptick in the number of workers who are relying on these single-fund solutions for their long-term investment needs. More than half of all plan sponsors now offer target-date funds, which hold about $165 billion in assets spread among 40 different fund families. And they've been deemed a fine idea for retirement savings by no less than the U.S. Department of Labor.

Despite their recent poor performance, sponsors of target-date funds are sticking to their guns. Says Ned Notzon, chairman of T. Rowe Price's asset-allocation committee: "We're not even remotely happy about 2008. This is the second worst year in our 187 years of data." But, says Notzon, the fundamental advantages of the funds will prove themselves over time. "If you're looking at a 15-, 20- or 30-year time horizon, this is just going to be a blip."

Those benefits start with diversification. Target-date funds invest in big-company stocks, small companies, foreign stocks, bonds and often less-traditional assets, such as real estate and even commodities. In normal times, diversification means that when one category drops another rises, dampening volatility. And when all categories of stocks perform poorly, bonds tend to shine.


But these aren't normal times. "With the exception of cash, there's been no asset class that was immune to volatility," says Jonathan Shelon, a co-manager of Fidelity's target-date funds. Sticking with cash is "kind of a feel-good strategy," he says, "but not one that can satisfy the requirements people have." To make a nest egg grow and keep it healthy during a retirement that can last 20 years or more, you need the relatively high returns of stocks.

Rebalancing is another, often-overlooked advantage. By periodically shifting funds from assets that have done well to ones that haven't, a portfolio tends to grow more quickly because managers are selling high and buying low.

Target-date funds manage risk by becoming more conservative the closer you get to retirement. That is, as the target date approaches, the fund reduces the percentage of assets invested in stocks and increases the portion devoted to bonds and cash. This so-called glide path is meant to dampen the fund's volatility, helping reduce the likelihood of big losses. But the recent market crash proved the exception to the rule when even bonds cratered.

The market crash underscored still another advantage of target-date funds: the absence of panic. T. Rowe Price reports that although investors withdrew money from many of the individual funds that its target-date funds were invested in, money continued to flow into the firm's target-date funds themselves. So simply not seeing which assets are really getting creamed enables investors to stick to their long-term goals. Says Christine Fahlund, a senior financial planner at T. Rowe Price, "Many investors shouldn't look under the hood."


Disappointing Returns

Bonds helped

Funds from the no-load families below charge below-average fees and are well managed. The 2015 funds have a higher percentage of bonds than the 2035 funds, which is why they performed better than the roughly 40% loss of Standard & Poor's 500-stock index in the past year.

Fidelity Freedom Fund 2015 –31% –6%
T. Rowe Price Retirement 2015 –34 –7
Vanguard Retirement 2015 –28 –4
Fidelity Freedom 2035 –42 –10
T. Rowe Price Retirement 2035 –43 –11
Vanguard Retirement 2035 –39 –8
Through Dec. 5, 2008.
Source: 2008 Morningstar Inc.