It's tempting to put your retirement on cruise control with a target-date fund. But even when you stash all your cash in one fund that makes all the investment decisions for you, it's still a good idea to keep your eyes on the road.
Here are some road signs for the autopilot investor:
Instant diversification. Target-date funds offer a premixed portfolio of stocks, bonds, and cash that a fund manager automatically adjusts to become more conservative over time based on the retirement date you select. Savers perplexed by investment choices can avoid having to pick and trade funds. "Generally, through a target-date fund, you should be broadly diversified enough that you don't need anything else," says Gregory Carlson, a fund analyst for Morningstar. Among new enrollees owning Vanguard target-date funds (one of the three biggest target-date fund providers along with T. Rowe Price and Fidelity), approximately 70 percent have their entire 401(k) nest egg in a single fund. "They were designed for people who don't have the time or the inclination to design their own portfolio," says Gerry Mullane, a principal in Vanguard's Institutional Investor Group.
Asset allocation varies. The definition of growing more conservative over time remains open to interpretation by each individual fund. For employees 10 years from retirement, equity exposure varied from 40 percent to 80 percent of the fund, according to a Watson Wyatt analysis of target-date funds in 2006. Equity allocations on the retirement day ranged from 20 to 65 percent. Morningstar found that some funds for employees retiring in 2010 still have almost 70 percent of assets in equities. "You have to take a look at what the worst loss would be with a particular allocation and see if you can handle that," advises Carlson. Also, some funds are actively managed, passively managed, or a combination. "Vanguard is a passive manager, and Fidelity is generally an active manager," says Mark Ruloff, director of asset allocation at Watson Wyatt.
Automatic enrollment. Target-date funds are increasing in popularity. Almost 80 percent of large U.S. plan sponsors offered target funds as an investment option through their 401(k) plans in 2007, up from 60 percent in 2006, according to research by consulting firm Greenwich Associates. An additional 48 percent of the remaining companies plan to offer one in the next two years. But even if you don't pick a fund, you could find yourself automatically enrolled in a target-date fund unless you specifically opt out. Life-cycle target retirement date funds are the top choice for automatically enrolled dollars, with 63 percent of participating companies using them as the default investment option, according to a recent online survey of 436 plan sponsors by Deloitte. "When someone new is hired, they're generally going to be automatically enrolled in target-date funds," says Ruloff.
Aim for low costs. Expenses are particularly important to consider when making long-term investments. "A lot of these funds are meant to be held for decades, so costs are going to make a big difference in returns over the long haul," says Carlson. Fees vary from fund to fund and over time as allocation shifts from more expensive equities to low-cost bonds. "Investors should generally look for funds that cost less than 1 percent," says Carlson. A recent Consumer Reports analysis found that Vanguard expense ratios hover around 0.2 percent, and T. Rowe Price and Fidelity charge between 0.6 and 0.8 percent annually.
Tinkering with retirement age. The one major decision everyone with a target-date fund has to make is picking the age at which you will retire. "The farther away from the target date, the more aggressive those investments are going to be," says Elaine Bedel, a certified financial planner and president of Bedel Financial Consulting in Indianapolis. You should pick a younger age if you want less risk in your portfolio. But future retirees chasing higher returns often pick older ages. "I would go with the Social Security default age, 67," says Ruloff. "If you aren't saving enough, then you might want to defer it to an older age."
Still need to save. Just because your investments are on autopilot doesn't mean you can be lax about 401(k) contributions. "Recognize that target-date funds are not a silver bullet," says Ruloff. "They cannot compensate for things such as undersaving."