Targeted funds aren't carefree

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When the mutual fund industry devised target-date funds for investors too flummoxed to manage retirement savings on their own, the premise was that investors could "set it and forget it." The phrase has taken on a whole new meaning for target-date fund investors this year, particularly those who are nearing retirement age.

Because of their large exposure to stocks, the three largest funds for investors planning to retire in 2010 -- Fidelity Freedom 2010 [Ticker: FFFCX] T. Rowe Price Retirement 2010 [TRRAX] and Vanguard Target Retirement 2010 [VTENX] -- have generated losses of 21 percent or more this year. That's a lot of ground to make up if you've already scheduled your retirement party.

Wall Street's woes could prompt workers -- particularly those nearing retirement -- and companies sponsoring 401(k) plans to fine-tune their use of the popular funds. Possible changes include making it easier for older workers to seek financial advice and adding features that protect assets as workers near retirement, says Pamela Hess, director of retirement research for Hewitt Associates.

The appeal of target-date funds is understandable: Without investors having to do anything, they are heavy in stocks early in their career and gradually become more conservative as retirement approaches. The Department of Labor has approved them as one option companies can use to invest the 401(k) contributions of workers who don't select investments on their own. Ms. Hess says the funds "are the No. 1 default option by far."

One issue that has to be addressed is the amount of stock in target-date funds for those near retirement. Because they are living longer and have to worry about inflation, investors approaching retirement need a significant percentage of stock in their accounts to generate sufficient returns. The less stock they own, the lower their probable returns and the more they would have to contribute.

That's why it's not unusual for 2010 funds to invest 50 percent in stocks. Some own even more.

"Needless to say, they've been eviscerated," said Craig Israelsen, a Brigham Young University family and personal finance professor.

Dr. Israelsen says the focus for those near retirement should be on protecting their money, "not on trying to hit one more home run." Target Date Analytics, a firm he co-founded, has developed four sets of indexes to measure the performance of target-date funds. The most defensive index for 2010 funds has about 8 percent invested in stocks. Comparable funds holding more than that are like jets trying to land at high speeds and a 45-degree angle, Dr. Israelsen says.

David Root Jr., chief executive officer of D.B. Root & Co., Downtown, believes that workers within five years of retiring should hold 25 to 30 percent in stocks, depending on their risk tolerance and need to tap the funds upon retiring.

He thinks the market swoon will prompt investors to re-evaluate target-date funds.

"They're going to start to look under the hood to see what their real risk exposure is," Mr. Root says.

A study by three Butler University professors concluded the best strategy is holding all stocks to within 10 years of retiring, then moving to a more conservative portfolio. Recent events require some modification of that strategy for those currently 10 years from retirement, says finance professor Steven D. Dolvin, one of the authors.

"I don't think now would be the appropriate time to sell [stocks]. You'd have to give it another few years," he said.

Dr. Dolvin says low-cost target-date funds are suitable for investors who don't have an adviser or who aren't sophisticated or disciplined enough to reposition their portfolio 10 years before retirement.

The one-size-fits-all strategy of target-date funds makes less sense as workers age and their situations get more complicated.

"People are looking for a silver bullet solution, and the investment industry has created target-date funds to be that magical potion," says Paul Brahim of BPU Investments, Downtown. "There is nothing in the world that works completely on auto pilot."

Mr. Brahim says those nearing retirement should set aside enough money to cover withdrawals they'll need to make in the first two years of retirement. With that in a safer asset, the stocks in the account will have time to recover from a downturn, he says.

Ms. Hess says target-date funds could start offering insurance that protects savings of workers near retirement. More employers will add advisory services to their 401(k) plans, she adds.

The need to rethink target-date funds illustrates that although they may appear to be a carefree product, there is no such thing. No matter what, investors have to be educated managers of their funds.

"They need to sit up and pay attention," said Sue Walton, a senior investment consult for Watson Wyatt.


Len Boselovic can be reached at lboselovic@post-gazette.com or 412-263-1941.


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