Don't shy away from target-date funds

— -- If you live in Wethersfield, Conn., you know something about long odds. On April 7, 1971, a meteorite crashed through the roof of a house in Wethersfield, giving the occupants a rude awakening and a lifetime of bragging rights.

Well, not exactly a lifetime. Another meteor fell on Wethersfield — about a mile from the previous strike — on Nov. 8, 1982, crashing through a roof and lodging in the living-room ceiling.

The odds of two meteor strikes in the same town are long indeed. Investors in target retirement funds were hit with a long-odds event last year. Could it happen again? Sure. But even though target retirement funds have their flaws, they're still a good idea.

Target-date funds let you choose the date you want to retire. As that date approaches, the fund slowly becomes more conservative. By the time it hits its target date, it is, essentially, an income fund.

The thinking behind target-date funds makes sense. You want to have lots of stocks in your portfolio when you're young, because you'll have lots of time to make up losses. As you approach retirement, you should lighten up on stocks and increase your diversification. After all, you wouldn't want to get hit with the financial equivalent of a meteor strike just before retirement.

But that's pretty much what happened to target-date funds during the most recent bear market. Funds geared for those retiring next year sank an average 35.6% from Oct. 9, 2007 through March 9. Those marketed to people retiring in 2020 swooned an average 44.8%. What happened?

A highly improbable financial meltdown, that's what. Normally, stocks and bonds move in opposite directions. Unless your fund owned something other than ultrasafe Treasury securities, however, its bond holdings probably exploded. Bond traders dumped high-grade corporate bonds as if it were the end of the world.

"No simulations were equipped to deal with that," says Jeff Knight, head of global asset allocation for Putnam Investments.

Many target funds also diversified into international stocks, which plunged along with U.S. stocks. Real estate and commodities got hit, too. With just one exception — Treasuries — any diversification strategy fell to Earth with a thud.