Target-date funds are spreading like wildfire. Many employers now automatically plunk your retirement savings into these especially easy investment vehicles. But for all their benefits, these funds can also present dangers to unwary investors. Happily, our friends at the SEC want to remedy that.

The big picture
Each target-date fund automatically adjusts the composition of its holdings as its preset retirement date approaches, shifting from riskier and more aggressive stocks toward safer, slower-growing bonds. Given many people's tendency toward procrastination, and lack of financial sophistication, these funds are quite appealing. As a result, one projection foresees assets in these funds growing 11-fold by 2018, to $2.6 trillion.

To snag a piece of this immense opportunity, smaller target-date fund players are scrambling to catch up with larger ones. According to a Morningstar report, Fidelity, Vanguard, and T. Rowe Price (Nasdaq: TROW) are the industry's biggest players, collectively controlling close to 80% of the market. Among a larger second tier of providers, Wells Fargo (NYSE: WFC) and BlackRock (NYSE: BLK) only have a percentage point or two of market share. But ING (NYSE: ING) and AllianceBernstein (NYSE: AB) have gone from almost no presence four years ago to multibillion-dollar target-fund businesses as of last year.

Target practices
However, if you peek inside, these funds can vary considerably in their asset allocation. Here are several significant differences I found among several 2030 funds:

Fund

Cash

U.S. Stocks

Non-U.S. Stocks

Bonds

Fidelity Advisor Freedom 2030 A (FAFEX) 10% 46% 22% 21%
Goldman Sachs Retirement Strategy 2030 (GRLAX) 4% 40% 43% 13%
Vanguard Target Retirement 2030 (VTHRX) 1% 65% 17% 17%
Putnam Retirement Ready 2030 A (PRRQX) 26% 29% 14% 30%
Oppenheimer Transition 2030 (OTHAX) 7% 64% 20% 9%

Source: Morningstar.

Clearly, we need to look beyond just fees, turnover, performance, and investment minimums to see how such funds invest. The differences above vastly determine what kind of returns shareholders will get. Yet many investors remain largely unaware of their funds' allocations, or how they compare with others'. In 2008, target-date funds for 2010 posted losses ranging from 9% to 41%.

SEC to the rescue
Our friends at the Securities and Exchange Commission are aware of this problem, and they've proposed a solution. The SEC wants target-date funds to feature their allocation mix in their name, or in a tagline adjacent to it. So for a 2030 fund, you might see a tagline such as "30% equity, 60% fixed income, 10% cash in 2030." I applaud the proposal, and love its boldness -- yet I still see a few problems with it:

  • If the information is in a tagline, rather than the name of the fund itself, it may still not be noticed by folks choosing funds for their 401(k) funds. It might be better to find a way to get it into the name, such as via a short convention such as "30-60-10."
  • But that's no less problematic. By their nature, these funds start out with one allocation and end with another, so any allocation they reveal is incomplete. The suggestion is to show the retirement-year allocation, but today's allocation arguably matters more, since retirement might be 30 years away. Fortunately, the SEC proposal also wants a graphic clearly laying out the intended path -- which might show the fund at 60% stocks now, shifting to 50% in 10 years, and 40% by the target date.
  • Besides, many employers' 401(k) plans will only offer target-date funds from one fund family, leaving investors without a good range of choices. In that case, investors might want to pick the fund with the allocation they like best, rather than one whose target rate most closely matches their retirement.

In short, the proposals aren't perfect, but they're certainly a step in the right direction.

If you still find target-date funds too confusing, remember that you can always manage your own asset allocation. You could create a perfect portfolio with just a few mutual funds and ETFs. Pick the ones you want, and allocate your money between them to best suit your goals and risk tolerance. Then adjust the allocation every few years as you approach and enter retirement.

Target-date funds seem here to stay. Just make sure you invest in them with your eyes open -- or simply do their job yourself.

While you focus on what to buy, don't sell what you shouldn't. Selling the wrong stock can hurt your portfolio.

True to its name, The Motley Fool is made up of a motley assortment of writers and analysts, each with a unique perspective; sometimes we agree, sometimes we disagree, but we all believe in the power of learning from each other through our Foolish community.

Longtime Fool contributor Selena Maranjian does not own shares of any companies mentioned in this article. BlackRock is a Motley Fool Inside Value pick. The Fool owns shares of T. Rowe Price Group. Try any of our investing newsletter services free for 30 days. The Motley Fool is Fools writing for Fools.