Mutual Funds: Targeted Allocation

Feb. 26, 2004 -- There are two kinds of investors:do-it-yourselfers and the rest of us. And mutual fund companiesknow it.

Some investors happily immerse themselves in market data,charting each success like a proud gardener with a prize-winningtomato. But most of us would rather be doing other things; we'reeither too busy or too bewildered to deal with our own finances.

With those anxieties in mind, some fund companies have launchedtargeted retirement funds — combinations of stocks and bonds thatautomatically rebalance over time. The idea is to provide simple,one-stop shopping for people who want to make all their long-terminvesting decisions in a single step.

Traditionally, experts have advised investors to continuallyadjust their portfolios, making them more conservative as the yearspass. Targeted funds do it for you, starting out more heavilyinvested in stocks, then gradually shifting toward bonds. All youhave to do is pick the fund targeted to the year closest to yourretirement date.

Pick Fund-Picker Carefully

First conceived for 401(k) participants, targeted funds aregaining popularity among people rolling over their retirementaccounts. Now, with new funds from T. Rowe Price Group and VanguardGroup, there are more choices.

Because these are "funds of funds," meaning they invest inother mutual funds within the same family, they're "only going tobe as good as the fund shops that offer them," said Kerry O'Boyle,an analyst with Morningstar Inc. So if you're considering atargeted fund, you'll probably want to choose one from awell-established company with plenty of market experience.

Although most targeted funds are set up in similar ways, theycan differ widely in terms of asset allocations.

For example, Fidelity Investment's Freedom 2020 fund,theoretically be aimed at a 50-year-old whose retirement is still16 years away, is about 65 percent invested in equities. Vanguard's2025 target fund has about 60 percent in stocks, while T. Rowe's2020 fund has about 75 percent.

"It's a question of approach, conservative versus aggressive… and over 20 years, that can really make a difference," O'Boylesaid. "What it really comes down to is how much an investor issaving in these funds. And they may not find out until retirementif they've been aggressive enough. I think T. Rowe has it right tohave more in equities."

T. Rowe's targeted funds rely on equity appreciation far longerthan other similar funds. They have a hefty 55 percent equity stakeat retirement, which is scaled back to about 20 percent over a30-year period. With more than 20 percent of people living to theage of 90, it makes sense to use a longer time-horizon, said JeromeClark, portfolio manager of T. Rowe's retirement funds.

"One thing we do understand is most investors are not going tospend a lot of time on this," Clark said. "Most people will spendmore time planning a summer vacation than they will on theirretirement account."

Conservative Choice

Vanguard's targeted funds, based on its well-known index funds,are more conservative, with an equity stake that scales down tojust 35 percent by retirement. Within about five years of maturity,the funds are merged with a static retirement income fund that is20 percent invested in domestic stock and 80 percent in bonds,mostly in Vanguard's total bond market index. "Because we know nothing else about the person besides theirretirement date, we erred on the conservative side," saidCatherine Gordon, a principle in Vanguard's investment counselingand research group. "As we unfortunately found out in 2000, youhave to take into account the portfolio's ability to take a hit."

Fidelity's targeted funds take a similar approach, but relylargely on actively managed funds, with some holding variousconcentrations of up to 20 different funds. Most companies charge expenses that are about equal to what aninvestor would pay to own the underlying holdings. But Fidelity'sFreedom funds include an additional 0.08 percent fee.

The biggest drawback of targeted funds is that, while they domuch of the work for you, they're not individualized. Mostcompanies will offer some guidance about how much you need toretire, but it's not the same as having a plan drawn up just foryou.

"Investors won't get hurt doing this, but they might not get asgood a result as they think they should," said Joel Javer, acertified financial planner in Denver. "People may be hopingthere's a magic solution to investing … but not everyone is goingto be well-served by the same one-size fits all investment."