RebelCapitalist: Financial Information for the Rest of Us | Target Date Mutual Funds: Investor Beware

Target Date Mutual Funds: Investor Beware

Nov 03, 2009 | By: Mr_Blue | Tags: mutual funds, target date mutual funds

Target date (or life cycle) mutual funds are mutual funds that invest in a portfolio of sometimes other mutual funds or investments based on an asset allocation that corresponds to the investors targeted retirement date. The asset allocations change automatically as a person gets closer to retirement date. So, if someone plans to retire in 2020 the money managers who manage the mutual fund may invest in say 50% bonds - 50% stocks. That is how target funds are suppose to work but be careful.

The idea of target date mutual fund sounds like a great idea particularly for people who are not familiar with investing. For many employers, these mutual funds are becoming the default option for 401Ks. Target mutual funds is becoming a big business - last year target date funds saw $57 billion in new investments.

Last year these funds, not surprisingly, took huge hits but the magnitude of the problem depended on the targeted retirement date. For people who had a target of 2010 - the losses were surprising huge - some 2010 funds lost as much as 40% of their value. This is surprising because with a 2010 target date the portfolio should be very conservative. The problem is that there are not any standards for these target date funds.

The Securities and Exchange Commission (SEC) recently discovered that target date funds vary widely in terms of their investment risks, even when they use similar target years or names. The data showed that target date mutual funds marketed to people hoping to retire in 2010 had anywhere from 21 percent to 79 percent of their holdings in stocks. That high end (79%) is way too risky for a 2010 retirement date.

These target date funds give a false impression that asset allocations are on automatic pilot and everything will be OK. But as the 2010 example shows that is far from the case. These funds actually require active investor participation as a person gets closer to retirement because of the lack of standards. This can be a huge problem for a person who is not familiar with investing. Imagine being in a mutual fund 2 years from retirement and still predominately in stocks - that is insane.

Don’t wait for the SEC or congress to act to improve disclosures or set standards. Read the target date mutual fund’s prospectus before investing and make sure the asset allocations are not extreme as 79% stock a couple of years from retirement, and, most importantly, make sure you are comfortable with the risk level of the fund. Ask questions and if it doesn’t pass your “smell test” don’t invest (assuming you have other options).

Good luck.

Sources:

New York Times, Target-Date Mutual Funds May Miss Their Market

U.S. News and World Report, Target-Date Funds Go Under the Microscope