Target-date and target-risk funds, which have enjoyed blockbuster success in terms of sales, might deliver lackluster results for 401(k) participants, according to Dow Jones. The “set-and-forget” appeal of these funds, which investors choose based on anticipated retirement date, or perceived risk tolerance, have brought incredible inflows in the past two years. In 2006 alone, the category saw $303 in inflows, a surge of 50%, following a 57% increase in 2005, according to data from the Investment Company Institute. “These funds are for those who want to take the easy way out,” said Susan Black, director of financial planning at eMoney Advisor in Conshohocken, Penn. However, the same thing that draws investors to these seeming silver-bullet funds may compromise their portfolios later. The problem is that because the funds focus on only one element, age or risk level, investors who use them may not be building well enough diversified portfolios, some warn. Good planning should take into account not just one element, but several including risk, age, tax concerns and overall objectives. “You really need to look at everything,” said Black. “The reality is that people really need holistic planning.” Another problem target-date and target-risk investors encounter is holdings overlap. If the average investor has 60% of his investments in stocks and 40% in bonds, between qualified and taxable retail accounts, he will have to calculate the proportion of his target-date holdings that are stocks to determine how much he should invest in other stock funds. Still, she said, these packaged fund-of-funds are better than not investing at all, or choosing extremes. Another danger is that the funds make broad assumptions about investors of a certain risk tolerance or age level. This is an especially important point if the funds do, in fact, become the qualified default investment alternative (QDIA) under the automatic enrollment provisions of the Pension Protection Act. “As far as QDIA, I think the big issue will be sustainability,” said Louis Harvey, president of Boston-based qualitative fund ranker Dalbar. “The older, wealthier employees are almost always better off with a fiduciary advisor who will do serious pre-retirement planning,” said Harvey. For investors, another tricky issue is deciphering the differences between similarly names funds. After all, what one company might consider moderate risk, compared to another company’s definition can vary significantly. “With target-date funds, you should do more than simply find the date that matches your age at 65, for example, and buy that fund,” said Christine Fahlund, vice president and senior financial planner at T. Rowe Price. “If it is currently too high or low in equities for your taste, it is important that you realize that and find a target date that matches your personal needs—both now and as it glides to other asset allocations in the future,” Fahlund said. Diligence is critical, even in such so-called worry-free funds, said Sheryl Garrett, who wrote “Garrett’s Guide to Financial Planning.” “No one should ever invest in anything and forget about it,” she said. “These target strategies do transfer the re-allocation work to the fund manager; but that reallocation will not include how the investor’s other investments are positioned,” she said. And that may mean a little more legwork up-front, said Fahlund. “Do your homework before you make your selection, and you’ll be a much happier investor over the long term,” she said. The staff of Money Management Executive ("MME") has prepared these capsule summaries based on reports published by the news sources to which they are attributed. Those news sources are not associated with MME, and have not prepared, sponsored, endorsed, or approved these summaries.
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