Over the past several years, target-date (or life-cycle) mutual funds have gained popularity as fund companies tout them as an easy way for investors to obtain an appropriate asset mix in their portfolio for a particular age or investment timeframe.
Theoretically, these funds are designed to allow an investor to select a date that approximately corresponds to their retirement – say 2020 or 2030, and the fund manager will attempt to provide an allocation of stocks, bonds, and cash that becomes more conservative the closer the individual gets to retirement.
The idea is that the investor can rest comfortably knowing that their investments are properly aligned with their risk tolerance and time horizon.
However, as an article in Fortune magazine recently pointed out, investors hoping that target-date funds would be a simple way to ensure they were properly managing risk have been shocked by the overly-aggressive nature of these funds.
The article points out that, “According to Israelsen, the average 2010 fund marketed to investors who were aiming to retire next year – was more than 45% invested in stocks in December. As of March 2008, the mammoth Fidelity Freedom 2010 Fund (FFFCX) housed 50% of its assets in equities, and AllianceBernstein’s 2010 portfolio (LTDAX) was 57% in stocks in February of last year. The funds lost 25% and 33%, respectively, last year, barely beating the S&P 500.”
Investors hoping to retire next year surely were not expecting a portfolio allocation that could expose them to 25% or 33% losses.
Industry professionals attribute the miserable performance of these funds to poor execution by fund managers, who in an attempt to chase extra returns that could help market the funds, added unnecessary risk to their portfolios by overexposing to equities. The performance has been so alarmingly bad that Wisconsin Senator Herb Kohl has asked the SEC and Department of Labor to investigate target-date funds, particularly since many employers offer these funds in 401(k) plans and brokerages aggressively market these funds to investors for individual retirement accounts.
The bottom line is that investors should be wary when considering these funds for their retirement accounts. In addition to the performance and asset allocation issues described above, expense ratios on these funds can be heavy and funds can include loads or commissions. Furthermore, the asset mix in these funds is generally limited to stocks and bonds, excluding other important asset classes such as commodities and real estate that can help balance out a portfolio.