Rocky Stock Market Tests Target-Date Funds

• ByHarper Willis, Special to TheStreet.com
• On 8:59 am EDT, Friday May 22, 2009

Target-date mutual funds, which shift to less risky securities over time, weren't conservative enough to keep investors close to retirement from losing money.

The average 2010 target-date mutual fund lost 25% last year, according to research firm Lipper. That's better than the 37% loss of the S&P 500 Index, but not what one would hope to see two years before they plan to retire.

Mutual fund firms introduced target-date mutual funds more than 10 years ago, billing them as a hassle-free way to save for retirement. However, the stock market spasms of 2008 pushed many target-date funds off their moorings. Now, investors planning to retire by 2015 are facing significantly smaller nest eggs.

Top performers: While many target-date funds posted dismal performances during the past year, some funds have weathered the recession fairly well. The SunAmerica 2015 High Watermark Fund is down 2.2%, a fraction of the 20% to 30% losses of competing funds with the same target date. The MFS Lifetime 2010 Fund has fallen 8.9% in the past year.

The best-performing funds filled their portfolios with high-quality bonds, avoiding the worst of the fallout from the subprime mortgage debacle, says Morningstar analyst Greg Carlson. While that strategy helped during the past year, there's no guarantee these funds will lead the pack next year.

Choosing the right fund: To pick a good target-date fund, you'll have to do some digging.

Morningstar mutual fund analyst Michael Herbst says investors should begin their searches with established companies like Vanguard Group and T. Rowe Price Group.

"Even if their funds haven't held up as well as others in the recent past, we respect these companies' ability to execute strategy effectively," he says.

A disciplined strategy is central to running successful target-date funds. When evaluating the funds, look at how their allocations change as they approach their end dates. Not all target-date funds follow the same pattern. Some might hold large stakes in riskier stocks even if the target date is five years out. Others might pile long-term portfolios with Treasuries that protect money but won't grow.

Make sure you're comfortable with the fund's strategy. Does it fit with your risk tolerance? Does it offer enough growth?

Investors should also compare funds' expenses, which can vary significantly. Carlson recommends looking for funds with modest expense ratios. After all, you shouldn't give back a chunk of your return as costs if you don't have to.

Target-date funds have gotten their fair share of bad press in recent months. While they might not be the right choice for everyone, they still offer a compelling option for investors who don't want the responsibility of managing their own portfolios.

Buzz up!