Are Target Funds more Aggressive than Advertised?

A recent commercial by a major fund company was marketing the easy approach to investing by using their target funds. The commercial starts off with a couple trying to explain their approach to investing as they approach retirement. The wife looks at the husband and says, “You tell them.”

The commercial makes both out to be very clueless about their investments as the husband declares, ”Well they move the money around at the right times for retirement…I don’t know, I just let the company take care of it.”

Welcome to the world of easy investing as marketed by the mutual fund industry. These target funds were designed for you not to think. You are instructed to figure out when you are going to retire and pick the fund that is closes to your retirement date. For example, if you were retiring in 2020, you would pick the 2020 target funds. If you were retiring in 2035, you would pick the 2035 target fund.

The whole idea is that the fund is intended to change risk levels as you get closer to your retirement. However, are these funds making the appropriate changes?

According to a Chicago-based Morningstar Inc. analysis of the 25 largest target date funds, some had between 20% and 30% of total assets invested in mortgage bonds and/or financial stocks. These are some of the riskiest investments you can own. So, can you imagine retiring in 2010 and taking some substantial unintended risk in your portfolio?

One 2010 target fund is -11% year to date. This fund has a 67% stake in stocks. So someone retiring in less than 2 years has a 67% stock exposure while in this fund. The fund brochure says it is designed for investors in their 60’s about to approach retirement.

How about a 2005 target fund? This is for someone already invested. One very popular fund from a large fund company is -8% year to date. That is for someone already in retirement.

Here is the bottom line when it comes to investing.

First, you can never go on autopilot as the mutual fund industry would like you to think. You need a system that will help you establish what is acceptable and what is not when it comes to your investment returns. For instance, there could be as much as a 10% difference between one of the worst target date funds and the best.

Second, if you are going to have a buy and hold type portfolio, you need a great deal more diversification than a target or lifestyle fund will provide.

Third, when investing in anything that is earmarked conservative, take a great deal of time investigating what it is that makes that fund conservative. There are too many examples of conservative funds that have lost a great deal of money.

Copyright © 2008 Prudent Money and Bob Brooks. All rights reserved.