Mutual Funds

The One-Stop Portfolio

The fund industry is confusing the issue, but for most people target-date funds are still the best way to save.

By Bob Frick, Senior Editor, Kiplinger's Personal Finance

February 2008

EDITOR'S NOTE: This article is from Kiplinger's Mutual Funds 2008 special issue. Order your copy today.

Target-date mutual funds are simply a great way to save for a long-term goal—especially retirement. The concept is simplicity itself: Choose the year you'll need the money, then pick the fund with the date closest to your target. So, for example, if you're 35 and plan to retire in 2038, you'd choose a fund with 2040 in its name.

These funds are a balanced meal of investments, complete with big-company stocks, small-company stocks, bonds and often less-traditional assets, such as emerging-markets stocks and real estate stocks. As the target date approaches, the fund becomes more conservative, lowering the percentage of assets in stocks in favor of more bonds and cash. This "glide path" is meant to dampen the fund's volatility, reducing the likelihood of big losses as you near the year you'll need to tap the fund.

Money in target funds has grown like kudzu since their introduction around the beginning of this decade—from $12.3 billion in 2001 to $168 billion at last word. The number of fund families offering target-date funds has jumped from a handful five years ago to 35 today. That number is bound to rise, thanks to a ruling by Uncle Sam. The U.S. Department of Labor recently issued guidelines that place target funds on the short list of approved default investments in employer-sponsored retirement plans.

Maybe it's because so many companies want a stake in the target-fund business that it seems everyone's a critic these days. Naysayers are accusing target-date funds of being inflexible, too risky or too hidebound.

But don't let such debate shake your faith. Much of the noise surrounding target-date funds is the industry overthinking a sweet and simple concept. For our favorite target-date funds, see How to Pick a Target Fund.

Getting aggressive

In an effort to improve performance and break from the pack, many target-date funds have boosted their holdings in riskier investments. While more-aggressive target-date funds topped out at 80% stock allocations three years ago, some now have as much as 94% in stocks, says Hewitt Associates, a human-resources consulting firm.

The growing slice of foreign stocks, in particular, underscores the push toward performance and the divergence among target-date funds. In recent years, one of the best ways to crank up a portfolio's performance has been to look overseas. The MSCI EAFE index, a widely used barometer of performance in developed foreign markets, returned an annualized 22% over the past five years to December 1, 2007. Standard & Poor's 500-stock index gained 11% annualized over that period.

Vanguard's target-date funds have up to 18% of their stock allocations in overseas companies. Compare that with the 22% maximum in T. Rowe Price target funds and the 35%-plus maximum in AllianceBernstein and John Hancock target funds.

Is putting so much in foreign stocks the right move? Time will tell. But you don't want your target-date fund to chase fads. Says John Ameriks, an analyst in the investment-counseling and research group at Vanguard: "I think a lot of the foreign-stock popularity is more about recent performance than good investing."

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