Keep These Funds on Target

Investors strapped for time and short on expertise often turn to mutual funds, where they can entrust their money to trained (and hopefully skilled) managers. But these funds can still let you down if you neglect them too long; their holdings won't always change to meet your financial needs as you age. Target-date funds offer a compelling solution to this dilemma -- but they've got their own downside, too.

Taking careful aim
Most companies in the target-date fund business provide a range of offerings, each focused on a particular retirement year. The Vanguard Target Retirement 2040 (VFORX) fund assumes that its shareholders plan to retire in 2040. Since that's more than 30 years away, its managers will initially keep more of its assets in stocks and less in bonds, increasing the likelihood of a higher return over the long haul. But over time, the fund will shift its mix toward bonds, reducing shareholders' volatility, and making a greater portion of their holdings more stable and secure.

Witness the varying portfolio mixes of the Vanguard Target Retirement 2020 (VTWNX) fund and the 2040 fund:

Target Fund Holding	% of 2020 Fund Invested	% of 2040 Fund Invested	Holdings Include ...
Vanguard Total Stock	55%	72%	Intel (Nasdaq: INTC  ) , Philip Morris International (NYSE: PM  )
Vanguard European Stock	7%	9%	Vodafone (NYSE: VOD  ) , UBS (NYSE: UBS  )
Vanguard Pacific Stock	4%	5%	Toyota (NYSE: TM  ) , Sony (NYSE: SNE  )
Vanguard Emerging Markets	3%	4%	China Mobile (NYSE: CHL  ) , CNOOC
Vanguard Total Bond	31%	10%	Treasury, agency, and corporate bonds

Source: Morningstar.

Proceed with caution
Before you get too intrigued by these investments, you need to discover their risks:

• Not all target funds are alike. Look up three different 2020 funds, for example, and you'll likely find three different asset allocations. And over time, each fund will likely shift its allocation in a different manner. Each fund family will also sport different fees, minimum investment amounts, and more. You'll need to find the right fit for yourself, hopefully with the lowest possible fees.

• Each fund can perform very differently, sometimes in surprising ways. During the crash of 2008, some target-date funds swooned more than investors expected. Even 2010 target-date funds lost 20% or more last year.

• If you invest in a target-date fund, be sure to view it as part of your overall portfolio. For example, you might think that the 70%-stock allocation in your fund is perfect for you, but if you have half your money in the target-date fund and the other half in other stock funds, you actually have 85% of your money in stocks! Keep your big picture in mind.

• If you don't find target-date funds with mixes or other characteristics you like, consider just building your own fund. You can do so by deciding what kind of asset allocation you want, and then investing in appropriate index funds. Over time, you can shift your allocation to suit your needs. 

Target-date funds are a great tool to get started with a simple retirement saving strategy. As long as you understand their potential pitfalls, they can serve you well for decades to come.

If you're wondering when to get started with your investing, listen to Brian Richards. He thinks that now's a great time to invest -- if you don't blow the opportunity.