One End Point, Divergent Paths
Sunday, July 13, 2008
NEW YORK -- Investors are often drawn to target-date mutual funds thinking that an investment run on autopilot is one less thing to worry about. But when the going gets bumpy, nonchalance can give way to urgent questions about whether to move money around.
The shared objectives of these funds, which automatically grow more conservative over time, can belie differences in how they carry investors to the finish line. The funds' appeal is in their set-it-and-forget-it approach: Pick a fund whose maturity is close to the year in which you plan to begin withdrawing money and let the portfolio managers do the rest.
But two funds with a target year of 2030, for example, might employ different investment strategies. Not understanding how a fund goes about investing can make it more likely that investors will become nervous in a down market and pull out. Panicking would introduce some of the emotion that these funds are designed to wall off.
Confusion among investors isn't surprising, experts say.
"They're being marketed on their solution approach, not based on the risk tolerance that the investor has," said Lynette DeWitt, research director at Financial Research Corp. in Boston.
In an examination of 58 companies that offer target-date products, FRC found great variety among funds with similar target dates. Among those with end dates of 2020, the amount of stocks held in funds' portfolios ranged from 51 percent to 95 percent.
And a quarter of the 2020 target-date funds that FRC reviewed said they would perhaps invest in areas other than stocks and bonds, such as real estate and commodities. These can be volatile but can move inversely to stocks.
It's hard to say which strategies are superior, in part because target date funds are only a few years old and because measuring their success while they are still years from their target dates could be akin to seeing a play in rehearsal well before opening night.
"In target date we have not only the now but the later," DeWitt said of the difficulty in squaring a fund's present standing with how its returns might look years later.
"There are diverse strategies and the thing is because we have a short history, we're not able to say clearly which strategy is the best for the market or for a group of investors. That's why there is confusion across the board on how to track performance," DeWitt said.
A poor short-term performance can increase the risk that investors will undermine their own investment strategy by exiting a fund in the early years when it might be expected to show volatility because it takes on more risks.
"Investors need to be aware of their own personal risk tolerance," DeWitt said.