Sometimes you just want a simple solution to your problem so that you can get on with your life. In Part 1, we looked at situations that called for the simplest of investing options--single mutual funds that provide a diversified portfolio appropriate for a variety of circumstances. These funds come under different labels--balanced funds, asset allocation funds, all-in-one funds, life-cycle funds and target-date retirement funds are the most common. Let's explore single fund investing solutions so you can determine if they may make sense for your situation.
Single fund investing solutions, or all-in-one funds, offer broad diversification both across various asset classes (e.g. stocks and bonds of various characteristics) and within asset classes (many different stocks and bonds from many diverse issuers). The investor could choose to get that level of diversification by using many mutual funds with different investment objectives, but the all-in-one fund provides the convenience of a single fund. Although all-in-one funds each seek to provide a broad level of diversification, they can then be split into two basic categories:
1. Target-date funds: Sometimes referred to as life-cycle funds, these funds set an asset allocation that is appropriate for an objective at a future point in time. The unique characteristic of the target-date fund is that the fund's asset allocation is dynamic--shifting to a more conservative allocation as the target-date objective gets nearer. (Target-date funds will be discussed further in this post.)
2. Balanced or asset allocation funds: These funds provide an asset allocation that is independent of any time-based objective. You can find balanced funds with conservative, moderate, or aggressive asset allocations, and these funds will presumably have the same or similar asset allocations 10 or 20 years in the future. (Balanced or asset allocation funds will be examined in Part 3.)
Target-Date Funds
Target-date retirement funds actually are a series of funds with varying target-dates for your retirement. It is common to see a series of about a dozen funds with target dates ranging every 5 years, say from 2005 to 2055, plus an income fund appropriate for those who have retired prior to 2005. The first series of target-date funds was introduced by Barclay's in 1993, and they have steadily gained in popularity. Today, over 25 different mutual fund families have target-date series. Although you will find them offered in the majority of employer sponsored retirement plans, you can also buy them as an individual investor through the fund company or a fund supermarket like Charles Schwab or Fidelity. Typically, target-date funds are "funds-of-funds", meaning that the target-date fund holds several underlying mutual funds.
When selecting a target date retirement fund you should give consideration to the following points:
This great discrepancy of asset allocations as you near retirement led to much controversy concerning target date funds after recent major downturn. Apparently, many investors thought having their money in target-date funds--funds that were supposedly transitioning to more conservative portfolios as they neared retirement--would protect them better when the market cratered. Although the target-date concept is a pretty sound one, the actual performance in various markets is dependent upon the implementation. And, it is certainly not a guarantee that you will not lose money in a down market. This is why you need to pay attention and choose a fund you can live with.
This certainly isn't everything there is to know about target-date funds. Hopefully, it is a good rundown on what you need to know to get started. These funds are simple and convenient, and offer the benefits of a professionally managed asset allocation that adjusts automatically over time. By putting your investments on auto-pilot you may also be insulating yourself from many common investor errors, such as failing to maintain an age appropriate asset allocation, failing to rebalance your accounts, chasing hot funds, or bailing out of the market at inopportune times.
In Part 3, we'll explore the second category of single fund solutions, balanced (or asset allocation) funds.
Next page: Disclosures