Will Your Target-Date Fund Retire Before You Do?

These cookie-cutter funds allocate retirement funds for you, but one size may not fit everyone.

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Target-date funds are always a target. When they fell sharply during the most recent stock market crash, the funds were slammed by critics. Too much equity, they said. Five years later, they get trashed for missing the stock market rally. Too many bonds, they say.

They draw attention just for their size—a half trillion dollars and growing—and also their unique position as the single financial asset millions of Americans choose in their workplace savings plans.

Unsurprisingly, after some of the funds dropped as much as 40 percent in the 2008-09 financial collapse, a noisy debate ensued. That uproar, which echoed through Congress and regulatory agencies, produced better disclosure rules for the target-date funds, but many investors are still confused about how to best use them.

"There is still a lot of misunderstanding about the funds, a lot of miseducation," says Lee Topley, managing director of Unified Trust's retirement plan consulting group. "Each fund family is different in fundamental ways."

What's the basic problem? "A target-date fund only takes one piece of data into consideration, and that is someone's birth date," says Topley. "It's like a doctor writing a prescription for high blood pressure for everyone who is 45 years old because the last five people that age who came into his office had high blood pressure."

[Read: 2 Simple Steps to Make Your Retirement Funds Leap.]

Not that there is anything wrong with blood pressure medication. "Target funds are the best 'default' choice for an average American's 401(k)," says David Edwards, president of Heron Financial Group LLC.

But one person's medicine can make another very unhealthy. Look at that prescription label for three items everyone should know about using target-date funds in retirement:

• What's is your glide path?

• What's the fund allocation?

• What fees are you paying?

Determine your retirement glide path. What these investment vehicles do when they reach their designation is a source of huge confusion. It is called the "glide path"—the trajectory you are supposed to hit when you stop working for retirement and start coasting on the funds you have saved.

A Morningstar Ibbotson study in 2011 faulted all of the major fund families for the way they handled their funds as they reach maturity, using terms like "shocking" and "chaotic." The study termed it a "bait and switch" because of the lack of clarity and many changes in retirement funds over the years.

The fund companies, fierce competitors for retirement dollars, have never come together even to define target funds "sell-by" date. Each has tried different approaches for the funds. There is not even agreement as to whether the funds should be set to carry "through retirement" or "to retirement."

While most of the largest funds purport to continue to serve both masters—the pre-retired and retired—one big provider says it really can't be done. ING says the goal ahead of retirement of accumulating and spending can't really be handled by the same fund. So it's worth looking at more deeply, financial advisers agree.

"When you reach retirement, you really should talk to a financial planner and think about whether a target-date fund is right," says Paul Zemsky, chief investment officer, multi-asset strategies and solutions for ING. "Potentially it's annuities, a balance between target-date and annuities. Each person needs to find the right mix as they get closer to retirement."

What's under the hood of your retirement investment vehicle? "A lot of people know more about what's inside their cellular phone contracts than their retirement funds," says Todd Rosenbluth, fund analyst for S&P Capital IQ. "They are not all alike, and you really should know what's inside."

It's especially important to look at the holdings if you own investments outside your workplace plan, says Rosenbluth. If you owned Apple stock last year, for example, you may have been overexposed since Apple is one of the most widely owned stocks among all mutual funds and is likely held in your target-date fund. Buying more would add to your Apple exposure, and maybe too much. "You'd be doubling down on Apple," Rosenbluth says.