A portfolio that you don’t have to tweak
An increasing number of workers will find a new option in their 401(k) plan this year: “target-date” retirement funds.
Target-date mutual funds are designed to provide one-stop retirement shopping for someone who doesn’t want to worry about asset allocation -- a portfolio’s mix of investment types such as stocks, bonds, cash, real estate and international securities.
“The beauty of this product is that once you select one, it does everything for you automatically for the rest of your life,” said Jerome Clark, portfolio manager of T. Rowe Price retirement funds.
Each target-date fund is designed for investors who are likely to retire in or near a particular year. The fund invests in other mutual funds to get a broad mix of assets. As the target date approaches, the mix of those assets is adjusted to become more conservative. For example, a 23-year-old could invest now in a fund with a 2050 target date and not have to think much about it for more than 40 years.
Because of their “set it and forget it” appeal, target funds have been soaring in popularity. They hold about $180 billion in assets, up 55% from a year ago, according to fund tracker Morningstar Inc.
Their use is sure to grow this year as more employers, encouraged by new regulations, offer them in company-sponsored retirement plans.
Despite their simplicity, there can be differences among companies’ target-fund offerings. That’s because different investment managers have different ideas about the best mix of assets for any given situation.
With that in mind, here’s a look at how target funds work and how you can determine whether a particular fund is appropriate for you.
If I plan to retire in 2020, can I assume that a retirement fund with a 2020 target date is right for me?
Not necessarily. Two funds that have the same target date but are managed by different investment firms can have significantly different asset allocations.
For example, let’s look at the 2010 target funds offered by Payden & Rygel, Vanguard and T. Rowe Price:
Payden’s 2010 fund holds just 38% of its assets in U.S. stocks, 16% in foreign stocks, 41.5% in bonds, 4% in real estate and 0.5% in cash.
Vanguard’s 2010 fund has 44.3% in domestic stocks, 11.2% in international stocks, 4.5% in inflation-protected securities and 40% in bonds.
T. Rowe has the highest proportion of stocks in its mix, with 48.9% in U.S. stocks, 12.3% in international stocks, 33.9% in bonds, 4.7% in cash and 0.2% in convertible securities, usually bonds, that can be converted into stock.
The higher the percentage of a portfolio allocated to stocks, the more you can expect the fund’s value to fluctuate from quarter to quarter and from year to year. However, a fund that is more stock-oriented also is likely to produce higher investment returns over time.
Why is there so much variation?
A fund’s asset mix reflects the fund manager’s approach to managing risk.
T. Rowe Price is most concerned about inflation risk, so it maintains a relatively high stock allocation because that would tend to protect investors from having their buying power eaten away by rising prices. Vanguard fund managers are more concerned about loss of principal than about inflation, so they hold comparatively less stock in their target portfolios. Payden & Rygel believes that the typical target fund doesn’t have a big enough exposure to real estate or international investments and that adding a measure of both creates a more efficient portfolio.
All of these approaches are valid. You simply need to consider which approach best matches your philosophy.
My company offers target funds through our 401(k) plan, but I think the fund for my retirement date is too conservative for me. What do I do?
You have two options. You can invest in the fund that reflects the date you expect to retire, and then invest a higher percentage of your non-401(k) retirement savings in stocks and other more volatile -- and potentially more lucrative -- options. Or you can choose a target fund that’s designed for someone younger than you.
Typically, companies offer a spectrum of target funds with retirement dates at five-year intervals. For example, your 401(k) might offer Vanguard’s Target Retirement 2010, Target Retirement 2015, Target Retirement 2020, etc. If you plan to retire in 2025, you might choose the 2035 fund to get the more aggressive investment mix you’re looking for.
Does it make sense to put just a portion of my retirement assets in a target fund and divvy the rest up among different mutual funds?
Probably not. The point of target funds is to free you from mixing assets yourself. If you like to allocate assets on your own, skip the target funds and do it yourself.
My wife and I both have 401(k) accounts. My employer gives me a target fund option, but hers doesn’t. How do we mix the two?
If you like your target fund’s approach, you can try to mimic it with your wife’s plan by checking the fund’s investment mix once a year and then adjusting your wife’s investment mix to reflect the same allocation.
Can I invest in a target fund outside a 401(k)?
Absolutely. You can buy target funds from almost any major mutual fund company and you can use them in taxable or tax-favored accounts, such as IRAs.
How do I know what the target fund is investing in?
Go to your fund company’s website and call up the fund. This will normally provide a snapshot of the fund and tabs to get more information. The tab you want will be called “composition,” “holdings” or “asset allocation.” That will show you the percentage of assets in each category.
What happens to a target fund once the target date has passed?
In general, the fund stays open and its asset-allocation trend continues, with the portfolio shifting further away from stocks. Some fund managers pare back their stock holdings fairly quickly; others will retain a significant exposure to stocks for decades. Make sure you ask and feel comfortable with the answers.
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Kathy M. Kristof welcomes your comments but regrets that she cannot respond to every question. Write to Personal Finance, Business Section, Los Angeles Times, 202 W. 1st St., Los Angeles, CA 90012, or e-mail kathy.kristof@latimes.com. For past Personal Finance columns, visit latimes.com/kristof.
