Inspect target funds
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 very 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 90 percent.
And a quarter of 2020 target-date funds FRC reviewed said they would perhaps invest areas beyond stocks and bonds such as real estate and commodities. These can be volatile areas 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 away from their target dates could be akin to seeing a play in rehearsal well before opening night.
“Investors need to be aware of their own personal risk tolerance,” DeWitt said.
She recommends that nervous investors examine a fund’s prospectus and marketing materials to learn more about the approach it takes. Even just a reminder that there is a long-term strategy in place could perhaps bring some comfort.
Patrick Waters, director of retirement investment products for Charles Schwab Investment Management, said investors looking for a quick way to broadly compare funds can look at how much exposure a fund has to stocks.
The back-and-forth in stocks can account for much of a fund’s volatility.
He said that while ups-and-downs aren’t necessarily bad, a fund that is adequately diversified can better level off a portfolio’s returns.
“It’s a fact that in different markets different products perform well and the more diversification that an investor has on average the better the return is going to be,” he said.