Last Updated: October 25, 2010
As open enrollment season approaches and investors keep looking for ways to dig out from their recession-era investment losses, the subject again turns to target funds — mutual funds with investments tailored to the particular retirement date the investor chooses.
Many employer-based retirement plans still offer these funds, which actually haven’t suffered substantial rejection from investors despite heavy losses and equally heavy criticism from federal agencies and politicians since the market collapse of 2008. One of the reasons target funds received such harsh scrutiny was that at the time of the crash, many near-date target funds — those with target dates of 2009 and 2010 — still held abnormally high levels of holdings in equities when they really should have been invested in Treasuries, high-rated bonds and other more secure investments.
A Morningstar report released in March acknowledged that the mutual fund industry responded to this wide criticism by cutting their high fees. Target funds have charged higher fees than, say, index funds because they are based on a fund-of-funds structure that layers a fee on top of the fees incurred by the individual funds. So that’s why it’s critical to understand the fee structure of any fund you invest in. In fact, Morningstar pointed out in March that the best target fund performers were those with the lowest fees.
Keep in mind that target funds will also be getting more transparency based on some recent proposed rule changes from the U.S. Securities and Exchange Commission. Among them:
- Marketing materials for target-based funds would have to disclose asset allocation for the fund by the category and actual name of the funds that reflect the category. This would allow investors to know exactly which mutual funds are used in their particular target fund so they can check individual performance and cost features.
- Fund materials would have to include a table, chart or graph that would show the various asset allocation and particular funds used in those allocations. The chart would be accompanied by a statement that explains how the asset allocation changes over time, how the allocation eventually becomes final and stops changing, the number of years after the target date where the asset allocation is fixed and details on that fixed asset allocation.
- A specific statement about risk tolerance, potential loss of investment and terms under which percentage allocations of investments might be adjusted without a shareholder vote.
So does this closer oversight mean it’s time to go back into funds that automatically invest for you?
It might be a better idea to take a thorough look at your finances before you make that choice. A visit to a financial planner would help you determine whether target funds make sense for your employment-based or independent retirement planning. Here are some basic questions you should be asking before you invest:
Do you know how much money you’ll need to retire? A successful retirement is not all about the retirement date. It’s about the quality and activities you’ll prefer in retirement and how much it will take to afford them. It is one thing to invest in a fund that promises consistent growth until a scheduled retirement date, but what if you need more growth? What if there are specific tax and spending issues that might interfere with putting the right amount of money into such funds each year? This is why individual advice makes sense.
What does your employer know about the target funds they’ve selected on your behalf? The Securities and Exchange Commission (SEC) has also outlined new rules that would make it easier for employers to see what they’re paying to put particular funds into their employee retirement plans. Be an activist. Go down to your benefits department and ask how these new rules are going to affect their selection process of particular fund investments and that they should share these decisions with employees. Ask them if they’re doing anything differently in the selection of these offerings since the rule changes. If they balk, just ask your co-workers to start asking similar questions until all of you get more clarification. At the same time, check the Morningstar rating of any fund your 401(k) invests in.
What if you leave your job? It’s a particularly good idea to talk with a financial planner about any decision to move assets if you leave a company, particularly if those assets are in targeted investments. Make sure your strategy stays in focus.