Are Target-Date Funds Off Target?

Less than 6% of investors can explain what target-date funds do, despite the fact that more than one-third of investors are contributing to such funds.¹ The popularity of target-date funds, coupled with the wide misconceptions about how these investments work and what they offer, can create a sticky situation for investors who have heard only the hype and are putting money into an investment they may not really understand.

What They Are

Target-date funds (also known as lifecycle funds) are hybrid mutual funds. Hybrid means they can contain assets from a variety of asset classes such as stocks, bonds, and cash alternatives. Typically, target-date funds are based on a date that corresponds to the date when the investor expects to retire or needs access to the funds. For example, an investor expecting to retire in 2030 might choose a 2030 fund. The mix of assets in the fund adjusts according to the target date and the “glide path,” a term used to refer to the formula that determines how and when assets are adjusted. In general, the mix of investments in the target-date fund gradually becomes more conservative as the date grows closer.

What They Aren’t

A recent survey found that many investors had misconceptions about target-date funds. For example, 61% incorrectly thought that target-date funds offered some sort of guaranteed return.² As with all mutual funds, the return and principal value of target-date funds fluctuate with changes in market conditions. Shares, when sold, may be worth more or less than their original cost.

Almost 85% of investors surveyed felt that target-date funds from different investment companies would be similar if they carried the same target date.³ It is important to note, however, that no two target-date funds with the same target date are alike. Typically, they won’t have the same asset allocation, investment holdings, turnover rate, or glide path. So it is important for an investor to look beyond the target date to determine whether a particular target-date fund is an appropriate investment.

Pouring money into any investment that you don’t understand can be especially risky. Target-date funds are not for everyone, so it’s important to gather all the facts.

Mutual funds are sold only by prospectus. Please consider the investment objectives, risks, charges, and expenses carefully before investing. The prospectus, which contains this and other information about the investment company, can be obtained from your financial professional. Be sure to read the prospectus carefully before deciding whether to invest.

1) Journal of Financial Planning, July 2009
2–3) U.S. News & World Report, May 8, 2009

The information in this article is not intended as tax or legal advice, and it may not be relied on for the purpose of avoiding any federal tax penalties. You are encouraged to seek tax or legal advice from an independent professional advisor. The content is derived from sources believed to be accurate. Neither the information presented nor any opinion expressed constitutes a solicitation for the purchase or sale of any security. This material was written and prepared by Emerald. © 2010 Emerald.