How to Aim for the Best Target-Date Funds

Millions of people would like nothing better than to buy a single mutual fund that would meet all of their investing needs. Target-date funds promise to give retirement investors that one-stop shopping experience, combining investments of different types into one package designed to meet the typical demands of those expecting to retire at a chosen future date.

But target-date funds have increasingly faced criticism on a number of fronts. Although the concept behind the funds is sound, products offered by various financial providers don't always let customers take full advantage of the benefits of target-date funds without paying too high a price.

The ins and outs of target-date funds
Most target-date funds share a similar concept. Aimed at people who have set their retirement date, the funds invest aggressively when investors have a long time horizon, but then gradually get more conservative as the target date approaches. Often using other mutual funds within their fund families, providers come up with what's often called a glide path to define how it will automatically shift assets toward more conservative strategies over the years.

One way in which target-date funds differ is in how they ease up on aggressive investments as the intended retirement date approaches. Before the market meltdown in 2008, many target-fund investors didn't realize the disparities across different funds, with some having far more exposure to stocks even near retirement than investors expected. In response, many companies have pulled back on their stock allocations in retirement. Earlier this month, for example, Prudential Financial announced its Day One funds that start with a 97% allocation to risky assets including stocks, real estate, and commodities, but gradually tone down that exposure to 35% by 10 years after the target date. By contrast, many providers have argued that given longer life expectancies, higher stock allocations are necessary to produce sufficient growth. That proved controversial in 2008's bear market, when many investors were surprised at the losses they suffered.

Focus on fees
But the more valid criticism involves how target-date funds are treated by various providers. Low-cost providers see them as a way of aggregating their fund offerings into an inexpensive, easy-to-invest unit. Vanguard, for instance, merely passes through the expenses of the underlying funds that each target-date fund invests in, rather than adding extra fees. T. Rowe Price appears to take a similar approach, with its more actively managed focus leading to higher fees than Vanguard's more index-based offerings but still reasonably inexpensive.

At other providers, though, target-date funds can get expensive. Legg Mason and Franklin Templeton charge up-front sales loads on some target-date funds classes as well as having relatively high expense ratios for management and other costs. For other classes, annual expenses can be quite high compared to Vanguard, T. Rowe Price, and other discount offerings such as Fidelity. Some of those expenses benefit investors in the stocks of Franklin Templeton and Legg Mason but don't necessarily add value for fund shareholders.

Make the most of your choices
Unfortunately, some target-fund investors don't have as much choice as they should. If you invest through a 401(k) plan, you're stuck with whatever options your company chooses. In such a case, you might do better avoiding a 401(k) target-date fund in favor of a cheaper alternative.

More broadly, though, you can choose whatever target-date fund provider you want in IRAs or in regular taxable accounts. Choosing a fund with low costs is your best way to keep more of your hard-earned investment capital for your own future financial needs.

Don't wait to hit your target
Despite the flaws some target-date funds have, they've been instrumental in getting many people to invest. Yet millions of Americans have waited on the sidelines since the market meltdown in 2008 and 2009, too scared to invest and put their money at further risk. They've missed out on huge gains and put their financial futures in jeopardy. In our brand-new special report, "Your Essential Guide to Start Investing Today," The Motley Fool's personal finance experts show you why investing is so important and what you need to do to get started. Click here to get your copy today -- it's absolutely free.

Tune in to Fool.com for Dan's regular columns on retirement, investing, and personal finance.You can follow him on Twitter @DanCaplinger.

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