Popularity Of Target-Date Mutual Funds Soars

Target date mutual funds take the hard work out of building a diversified portfolio. And judging by their soaring popularity, investors appreciate the convenience.

Target date funds, also known as lifecycle funds, assemble different asset classes into a single portfolio with weights geared to a specific year in the future.

Target date funds, TDF, are most frequently used for retirement savings in 401(k) plans and IRAs with the target date being an investor’s expected retirement year.

The TDF structure is also used for 529 college-savings plans with the target date being a student’s college enrollment year. Fund managers handle asset allocation and rebalancing, shifting gradually from a growth objective to one focused on capital preservation and income.

TDF funds continue to attract new investors. Assets in such funds reached $334 billion in 2010, an increase of 82 percent over the last three years, according to Financial Research Corp. Among 401(k) participants, 33 percent now own a target date fund. And for college savers, 35 percent of 529 plans sold through financial advisors use target date or age-based portfolios.

Using TDFs effectively gives you the best chance of reaching your long-term goals. But before putting your savings on cruise control, take stock of these four common mistakes that can derail a target date approach.

1. Choosing the wrong glide path

Not doing your homework is the most common and curable error for target date investors. You should know that the target date is the year when you’re expected to shift from saving to spending. You’ll also want to study the glide path, the manager’s plan for shifting a fund’s allocation over time from mostly stocks to less risky assets.

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“My sense is that investors don’t think about the glide path and how it works,’’ says Jeff Kostis, a certified financial planner in Vernon Hills, Ill. Not understanding glide paths can leave investors in allocations that may be too aggressive or may become too conservative too soon.

Retirement target date providers fall into two camps on glide paths. A growing number of firms target longevity risk — the chance you’ll run out of money in retirement — and maintain higher equity weightings at the target date and well into retirement. These types of lifecycle funds are known as “through retirement” funds.

Others worry primarily about market risk, the chance your principal will lose value, and shift to bond- and cash-heavy allocations by the target date. These are commonly called “to retirement” funds.

“The debate used to be how aggressive should you be at retirement,’’ says Steve Utkus, head of the Vanguard Center for Retirement Research. “ Now it’s how aggressive should you be into retirement.’’

2. Assuming all target date funds are the same

Look under the hood of funds sharing the same target date and you’ll discover vast differences in glide path, cost and management style. “There’s no consistency across the different companies and that creates a lot of problems,’’ says Kostis.

For funds with a 2010 target date, stock exposure ranges from a high of 67 percent to a low of 20 percent. For 2015 funds, the range is even wider: 75 percent for the most aggressive funds to 20% for the most conservative.

“That’s a huge difference in volatility,” Kostis adds.