Target-date Funds: How They're Faring In A Down Market

Investments for Individuals in or Near Retirement Lost Less Than S&P 500 Index

While the gyrating stock market may have scrambled some retirement nest eggs, holdings in near-term target-date funds have emerged relatively uncracked.



Target-date funds for those in or near retirement -- those structured for people retiring between 2005 and 2010 -- have lost less than the Standard & Poor's 500-stock index, according to Morningstar Inc. The average total return among these funds was a decline of 4.8% from Oct. 1 through Feb. 20, compared with a decline of 10.2% for the S&P 500, including dividends.

Although that is a good relative return, any decline can be unnerving, especially if the investor has already exited from the work force and is relying on savings for income. While not perfect, staying in a target-date fund is a good choice for many investors, especially those who don't have the time, knowledge or professional help to build a diversified portfolio.

One advantage to the funds is that they stay invested in stocks throughout retirement, something even the most risk-averse investor shouldn't avoid. That is because most investors need to continue to build their portfolios in retirement.

"The growth of capital is as important as the preservation of capital," says Gary Terpening, a product manager with Seligman Advisors Inc., an affiliate of New York-based J. & W. Seligman & Co.

Target-date funds, which first began to appear in the 1990s, offer a diversified portfolio that automatically adjusts as investors age, taking less risk as they approach and enter retirement by moving into cash and bonds. They were designed for the disengaged investor but have grown in popularity. There are now close to 40 companies offering 260 individual funds.

"A lot of people will eventually use this type of product for retirement needs," says Tom Roseen, a senior research analyst at Lipper Inc. He says that investors may be able to get better returns if they select their own mutual funds, but most don't know how to create well-diversified portfolios.

Participation in target-date funds is expected to increase because a growing number of employers are opting to automatically enroll workers into 401(k) plans with a default option of a target-date fund, says Clare Bergquist, director of 401(k) strategies at Charles Schwab Corp.

Investment in the market always entails volatility. But target-date funds vary significantly in how much they move in reaction to the market's swings, according to Tom Idzorek, director of research and product development at Ibbotson Associates.

For example, some funds for retirees have as much as 70% in stocks while others have less than 40%. "Different people have different tolerance to risk," he says. "Some of us are comfortable with volatility and some are not."

Mr. Idzorek expects the number of funds to grow and the funds to become even more individualized. The downside is that it could make the funds more complicated. He says investors should consider not only risk tolerance but also what else they have in their portfolios. For example, he says, investors could pick a more aggressive target-date fund if they expect to receive a pension during retirement.

Jeff Tyler, a senior portfolio manager at American Century Investments, says its income portfolio funds have 45% in stocks. "Maybe you won't be the richest kid on the block, but you won't be the poorest either, and you're much more likely to reach your target," he says.

Mr. Idzorek does, however, note one problem with target-date funds: Investors may set it, forget it and not know until it is too late whether they have saved enough for retirement. He advises not to leave the workplace without running the numbers.

Bottom line: With volatility looking as though it may stay awhile, target-date funds can bring some measure of stability.