Among the newest investment options for 401(k) investors are target-date funds, also known as life-cycle funds. These funds didn’t exist 10 years ago, and they had already amassed $256 billion in assets under management at the end of 2009, according to the Investment Company Institute.
A target-date fund is an asset-allocation fund that invests in a variety of asset classes — such as cash and aggressive-growth stocks — often through buying shares of other mutual funds. Participants find the funds attractive because they let you make an investment decision once and then forget about it.
Their distinguishing feature is that they gradually change their allocations as they approach a specific target date that’s roughly equal to the date that investors in the fund plan to retire.
For example, a fund designed for workers who were 35 years old in 2010 and plan to retire 30 years later would have a target date of 2040. Mutual fund companies usually offer funds with target dates 10 years apart, though some offer funds on five-year intervals. New target-date funds are periodically created to cover the latest entrants to the workforce.
Because most investors become more sensitive to losses the closer they get to retirement, a target-date fund’s asset allocation becomes steadily more conservative over time.
You can see one possible baseline allocation in the accompanying figure. Because the allocation to stocks steadily declines over time — in hopes of creating a smooth landing for the investor — the asset-allocation pattern for target-date funds is known as the glide path. (Projected retirement is at year zero in the x-axis.)
But the glide path shown here is just hypothetical. In reality, funds with the same target year — but offered by different fund companies — can have vastly different asset allocations.
Their performance can vary widely as a result, as highlighted in the market turmoil of 2008. Target-date funds with more exposure to stocks fared less well during the credit crisis than those with a more conservative allocation.
Excerpted with permission of the publisher, John Wiley & Sons, from “The Fund Industry: How Your Money is Managed ” (2011).