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Target-date fund pros and cons

Your 401(k) plan options probably include at least one target-date fund. Some financial planners tout these funds as a way to keep your portfolio appropriately allocated throughout your working career all the way to retirement. But others think they're a disaster. Who's right?

First, a brief primer: Target-date funds are composed of several funds representing different investment styles or asset classes. As their name suggests, they have a target date, such as 2020 or 2040, for retirement (or in the case of 529 plans, for college matriculation). The investment firms running these funds make the asset allocation decisions on behalf of investors based on the target date.

Is simpler better?

Ronald J. Rough, CFA, director of portfolio management at Financial Services Advisory in Rockville, Md., says that target-date retirement funds try to make a complicated scenario -- how to invest over 30 or more years -- simple. Or at least simpler. They generally start out more heavily weighted in equities, then grow more conservative as your retirement date draws closer.

"Simplification" is one of the advantages of target-date funds, says Certified Financial Planner Benjamin J. Muchler, vice president and portfolio manager at Boston Research and Management. "This isn't a magic pill that guarantees a particular return or eliminates the risk of loss, but it brings a level of portfolio management and complexity that is typically out of reach (for most investors)," he says.

On the other hand, for Certified Financial Planner Jon L. Ten Haagen of Ten Haagen Financial Group in Huntington, N.Y., "simplification" may be part of the problem. Target-date funds "can be one-size-fits-all," he says, whereas your current situation, risk tolerance, other assets and retirement needs are very individual.

Rebalancing balancing act

Muchler says that one advantage of target-date funds is that they "take the responsibility for rebalancing out of the investors' hands. Even if investors do a great job of picking the right funds initially, it's unlikely they're going to review and rebalance them every quarter."

Rebalancing a portfolio can require selling what's doing well so that you don't become overinvested in one particular asset. "It's hard for people to sell the funds that are doing well and to buy the ones that aren't. Having someone else do the rebalancing takes the emotion out of it," says Muchler.

But Ten Haagen contends that most of these funds don't rebalance often enough. "They rebalance every few years at best -- maybe every four or five years," he says. "If one had a fund in 2006 or 2007, they went from Dow 9000 to 14000 and back again." Without fairly frequent rebalancing, investors in these funds may have gotten hurt at the top of the market, with too much equity exposure, and at the bottom of it, with too much fixed-income exposure as the market rebounded.

It's what's inside that counts

Even if you're not retiring for another 20 years, Muchler suggests examining the company's target-date fund for current retirees to gauge what your portfolio might look like in the future. "If there are a lot of volatile assets in there, that could be a problem."


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