Target-date funds have taken a beating the past few years by many investment commentators. Some criticism may be warranted, but there are several myths I think must be debunked about these funds.
* Myth #1: Performance has fallen short for retirees and pre-retirees. When critics bemoan the poor returns of target-date funds, they're generally reaching back to the worst-case 2008 performance of a single 2010 fund that plummeted 41%. That's far from the experience of most investors.
Based on Morningstar data and weighted by dollars invested, the average 2000 to 2010 fund plunged 23.8% in 2008. Agreed, that's not an easy number to swallow for individuals approaching their retirement years.
However, research by Vanguard's Investment Counseling & Research Group indicates that most investors stayed the course and enjoyed the subsequent market rebound. In fact, over the three-year period that ended Dec. 31, the average fund in the 2000-2010 Morningstar category returned an annualized 1.5%, weighted by net assets. The performance of target-date funds during one of the worst financial markets in history should be put more fully in the perspective of the recovery that followed.
* Myth #2: The fees are outrageous. Actually, most target-date funds offer reasonable value for a balanced, diversified investment program.The average net asset-weighted expense ratio for the three largest target-date fund families is 0.57%.
* Myth #3: Investors don't understand the funds. Research actually shows that people understand much more about these funds than critics contend.
According to a 2010 survey by Vanguard, 85% of plan participants who are aware of target-date funds believe that the funds involve more than "very little" risk. The majority also knows that the asset mix in these funds becomes more conservative as they approach their targeted retirement years. And less than 10% of those surveyed say they believe target-date funds become risk-free or that they provide a guaranteed return.
Virtually no one is suggesting target-date funds are the optimal solution for everyone. Those investors who have enough knowledge and motivation can assemble a prudent portfolio on their own. Others may want to work with an advisor to craft a specially tailored portfolio.
But there are many investors who do not have the time, inclination or means to develop a well-rounded investment program for retirement. For these investors, target-date funds remain a viable solution.
John Ameriks, principal, leads Vanguard's Investment Counseling & Research Group.