Target-date mutual funds, also known as lifecycle funds, sound like the perfect choice for a time-strapped investor, a kind of "set it and forget it" solution to the problem of retirement portfolios.
What could be easier? You choose the fund closest to the year you plan to retire, hand them your money, and a fund manager somewhere does all of the asset allocation and rebalancing necessary -- and they'll keep on doing it, right up to and past your retirement.
But although the theory is the same -- a higher concentration of stocks when you're farther away from retirement, and a higher concentration of bonds when you're closer to retirement -- different funds allocate money differently. And that means varying returns -- and risks -- for you.
All target-date funds are not alike
Take a look at the different ways these three fund families allocate assets:
Fidelity Freedom Funds
|
Stocks |
Bonds | |
|---|---|---|
|
2010 |
51% |
44% |
|
2015 |
56% |
41% |
|
2020 |
68% |
32% |
|
2025 |
71% |
29% |
|
2030 |
81% |
19% |
|
2035 |
83% |
17% |
|
2040 |
85% |
15% |
|
2045 |
86% |
14% |
Vanguard Target Retirement Funds
|
Stocks |
Bonds | |
|---|---|---|
|
2010 |
54% |
46% |
|
2015 |
63% |
37% |
|
2020 |
71% |
29% |
|
2025 |
78% |
22% |
|
2030 |
86% |
14% |
|
2035 |
90% |
10% |
|
2040 |
90% |
10% |
|
2045 |
90% |
10% |
T. Rowe Price Retirement Fund
|
Stocks |
Bonds | |
|---|---|---|
|
2010 |
59% |
35% |
|
2015 |
67% |
27% |
|
2020 |
75% |
20% |
|
2025 |
82% |
15% |
|
2030 |
87% |
10% |
|
2035 |
89% |
7% |
|
2040 |
89% |
7% |
|
2045 |
89% |
7% |
The differences here aren't large, but over 40 years, they add up. Using the historical averages for stocks and bonds, I estimated what a $10,000 investment might return in these fund families over 40 years, assuming their allocations remain roughly the same:
|
Fund Family |
40-Year Return on $10,000 |
|---|---|
|
T. Rowe Price Retirement Fund |
$263,513 |
|
Fidelity Freedom Funds |
$358,170 |
|
Vanguard Target Retirement Funds |
$446,645 |
Those small differences add up to a 70% variance -- and that's a lot come retirement. Of course, the more aggressive allocation also opens you up to greater risk -- and you never know what the market will be like on the eve of your retirement.
But if buying a target-date fund includes having to research different allocation strategies and run simulations to figure out which one might best balance risk and returns for your particular situation, well, so much for set it and forget it.
Build your own!
Since finding a good target-date fund is more difficult than it seems, why not create your own? Our own Robert Brokamp, advisor to our Rule Your Retirement investment service, suggests the following asset-allocation model:
|
Conservative |
Moderate |
Aggressive | |
|---|---|---|---|
|
Large-cap stocks |
20% |
35% |
50% |
|
Small-cap stocks |
5% |
10% |
15% |
|
Foreign stocks |
5% |
5% |
10% |
|
Bonds |
60% |
40% |
20% |
|
REITs |
10% |
10% |
5% |
Choosing well-run, no-load mutual funds or index funds will give you ample diversification while simplifying the tracking and rebalancing of your portfolio. Take a look at these possibilities for further research:
|
Fund/ETF |
5-Year Annualized Return |
Significant Holdings | |
|---|---|---|---|
|
Large-Cap Stocks |
T. Rowe Price Equity Income (PRFDX) |
8.4% |
Microsoft (Nasdaq: MSFT), Johnson & Johnson (NYSE: JNJ), 3M (NYSE: MMM) |
|
Small-Cap Stocks |
Third Avenue Small-Cap Value (TASCX) |
14.7% |
Brookfield Asset Management (NYSE: BAM), K-Swiss (Nasdaq: KSWS) |
|
International Stocks |
Dodge & Cox International (DODFX) |
22.1% |
Novartis (NYSE: NVS), Honda (NYSE: HMC) |
|
REITs |
DJ Wilshire REIT ETF (RWR) |
14.9% |
Simon Property Group, Boston Properties |
|
Bonds |
Managers Fremont Bond (MBDFX) |
4.2% |
U.S. Treasuries, U.S. Corporate Bonds |
Rebalancing your portfolio annually -- and then only if asset classes are 10% or more away from where you want them to be -- will help ensure that you're achieving the balance of risk and reward you want for your portfolio.
The Foolish bottom line
Target-date mutual funds can be convenient, but like many conveniences, they may cost you.
If striking out entirely on your own is too daunting, consider the Rule Your Retirement investment service. You'll have access to all back issues, model portfolios, and the support of other subscribers on our boards.
You can try the service free of charge for 30 days -- with no obligation to subscribe. Click here for more details.
Julie Clarenbach does not own any of the stocks mentioned. Dodge & Cox International is a Motley Fool Champion Funds recommendation. Microsoft and 3M are Inside Value selections. Johnson & Johnson is an Income Investor choice. Brookfield Asset Management is a Global Gains pick. The Fool has a disclosure policy.
