Q: Are target-date or life cycle funds a good idea? I’ve read that they can become too conservative too soon, reducing potential earnings.
A: Target-date funds are an increasingly popular option in many employer retirement plans. The Investment Company Institute says target-date funds have grown from about $2 billion dollars in assets in 1997 to $183 billion in 2007. Roughly 5 percent of the assets held in employer-sponsored retirement plans are invested in target-date funds.
These funds allow an employee to choose a retirement date — 2030, for example — and invest assets accordingly. Typically, the funds invest aggressively early on in an attempt to earn higher returns, then become increasingly conservative, placing more of the money in safer investments — usually bonds — carrying less risk and usually lower returns.
Investment adviser Don DeWaay, founder of DeWaay Capital Management near Des Moines, Iowa, said target-date funds likely perform better than an inexperienced individual who might try to handle their own money.
DeWaay said a few things about the funds concern him:
•Target-date funds are a relatively new product so their true track record over time is unknown. The funds base their modeling on historical market performance and future performance may not reflect that level of return.
•There are large differences from one company to another about how target-date funds operate and how assets are allocated, so research is advised before you settle on one.
•DeWaay believes you’ll also want to pay close attention to diversification. Some funds focus mostly on domestic stocks and bonds, excluding other investment categories such as real estate securities or international assets that better balance your risk.
•There’s a risk that a fund may become too conservative too soon, reducing potential earning capability while others might leave assets in risky holdings until close to retirement.
DeWaay acknowledges that most people don’t have the time, resources or desire to actively manage their retirement savings themselves or to hire their own adviser. He said for many people in this position, placing money in a target-date fund is an acceptable option.