Value Added
Target Funds are Simply Flawed
One-stop retirement funds are simple, but they tend to limit their picks to one company, add an extra layer of fees and invest too conservatively.
By Steven Goldberg, Contributing Columnist, Kiplinger.com
June 7, 2005
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Investors -- particularly those in retirement plans, such as 401(k)s -- are flocking to super-simple, "target retirement" funds. Who can blame them?
Most people lack the time and energy to put together sensible investment plans, and after the tech-stock collapse, a lot more of them are willing to acknowledge that fact. Better to turn the job over to a competent professional.
Target-retirement funds are "funds of funds" assembled by pros. Surprisingly, however, there are plenty of lousy target funds -- and precious few good ones.
In theory, target funds are simplicity itself for investors. All you have to know is what year you plan to retire. Retiring in 2030? Put your money in Fidelity Freedom 2030 or T. Rowe Price Retirement 2030. That's all there is to it.
The fund company allocates your money -- at first aggressively, and then more conservatively, as you near retirement. So initially, you get a stock-heavy portfolio that gradually shifts more into bonds as you near retirement.
What's more, the fund company makes sure you have a proper amount in foreign stocks, growth stocks, value stocks, large stocks and small stocks. Don't know the difference between a growth stock and a value stock? You don't have to with a target fund.
The problems
But the reality is that most of these funds are badly flawed. To start with, they usually invest solely in other funds offered by the same company. There should be no additional layer of fees on such a product. But there often is.
Next, most fund companies simply don't have a broad enough lineup of good funds to offer solid target funds. It's not enough for a company to have a few good funds -- or even a bunch of good growth funds -- to put together decent target funds.
In my opinion, Fidelity, T. Rowe Price and Vanguard are the only three fund companies with enough top-drawer funds covering all the investment bases to assemble first-rate target funds.
Even then, having the right ingredients, although essential, isn't sufficient to offering first-rate target funds.
Too conservative
Vanguard and Fidelity target funds are too conservative. Take Fidelity Freedom 2030. It has just 80% of assets in stocks. The rest is in bonds and cash. Vanguard Target Retirement 2035 is even worse. It has just 77% of assets in stocks.
Now, please tell me why an investor with 25 or 30 years to go before retirement would want so much money out of the stock market? Bonds, which historically have averaged about half the 10%-plus annualized returns of stocks, have never come close to matching stocks over such long periods.
Why are Fidelity and Vanguard overly conservative? I think the answer is marketing. They're afraid investors will bail if a fund loses too much, so they load up the funds with bonds to limit volatility.
So is there a good target fund anywhere?
Thankfully, yes.
The T. Rowe Price Retirement funds are, far and away, the best choice. The 2030 fund has 90% of assets in stocks, and most of the bonds are high-yielding "junk" bond funds. Plus, the fund includes T. Rowe Price Small-Cap Stock -- a fund that's closed to other investors.
So, if you're looking for a one-stop way to invest your IRA or other retirement account, grab one of the T. Rowe Price Retirement funds.
Of course, if you're in a 401(k), you may have to choose among other options. In that event, look at what's inside the target retirement fund. By investing as though you were a younger person, you may get around the over-conservative problem. For instance, if you're retiring in five years, the Vanguard 2025 fund may be just right for you.
But the bottom line is that investors in most 401(k)s are going to have to continue analyzing funds the old-fashioned way.