By NELLIE S. HUANG Money Power on Aug 17, 2013, at 2:26 AM Updated on 8/17/13 at 3:54 AM
Before you invest in a target-date fund, look under the hood. TDFs, which are a staple of retirement plans, are only as good as their underlying holdings.
In addition to getting to know the mechanics, you'll learn how the target-date portfolio tilts toward more narrowly defined classes, such as foreign stocks, small-company stocks, real estate trusts and high-yield bonds.
Some TDFs, such as those offered by American Funds, hold only actively managed funds. Others, such as Wells Fargo, use only index funds. Still others, such as Schwab, hold both active and index funds.
To add to the confusion, some firms offer multiple target-date products. TIAA-CREF has one index-based series and another series that uses only actively managed funds.
Index funds either do a good job of tracking the index they're designed to mimic, or they don't. In most cases, how well an index fund performs is determined by the fees it charges.
Assessing actively managed funds is trickier. Start by favoring funds that have been run by the same manager for at least five years and have beaten, or at least matched, their peers or an appropriate benchmark over that period. In addition, scan calendar-year returns going back to at least 2008. A TDF holding that has lagged its benchmark for more than three or four years is a cause for concern.
The average annual expense ratio of the lowest-cost share classes of all target funds is 0.7 percent, says BrightScope, which rates and analyzes 401(k) plans. That includes the costs of the underlying funds as well as any additional TDF management fee.
You may not have access to the cheapest share class of your fund, but you can use the 0.7 percent figure to judge the costs of your target-date series. Depending on the share class, the expense ratio for Wells Fargo's index-based target-date funds ranges from an average of 0.35 percent to a shockingly high 1.63 percent per year. Vanguard, the industry fee leader, charges an average of 0.17 percent annually. Fund prospectuses and your quarterly 401(k) statements include information about expense ratios. As always, the lower, the better.
Judging a TDF's overall results can be especially challenging. A TDF's ever-changing allocation and its broad mix of asset categories make it difficult to match the funds with appropriate indexes. Still, you can get a rough idea of a TDF's relative performance by comparing your fund with TDFs with the same target year at Morningstar.com.
But your best bet is to focus on some basic criteria: fees, the strength of the underlying funds and how the fund shifts its allotment to stocks, bond, cash and other asset classes over time.
Nellie S. Huang is a senior associate editor at Kiplinger's Personal Finance magazine. To send her a question or comment, go to
tulsaworld.com/kiplingerfeedback.
Original Print Headline: Know your target-date fund
Money Power
As a group, the seven bond mutual funds in the Kiplinger 25 fared slightly better, but still suffered an average loss of 3.1 percent.
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