Set It and Forget It with Target Funds

09/24/2007 12:00 am EST

Focus: FUNDS

Tim Middleton, contributing editor to MSN Money, shows how target retirement funds can help investors plan for retirement and not outlive their money.

With baby boomers and their billions of dollars racing toward retirement, mutual funds geared specifically for them are among the fastest growing in the industry.

They're one-stop funds—designed to be able to stand alone in a portfolio—and typically marketed as investments appropriate for a person planning to retire in a specific year. There are 2010 funds, 2020 funds, etc.

Even if the simplicity that target-retirement funds offer appeals to you, even the best of them expose you to a serious hidden risk—outliving your money.

Fortunately, there's a simple solution. Add five to the expiration date on the label. If you plan to retire around 2010, buy a 2015 fund. The negligible risk to your principal that you will incur is more than compensated for by the higher returns you'll require for the additional years you can expect to live.
Morningstar limits its target-retirement Analyst Picks to T. Rowe Price and Vanguard. I would add a third, Fidelity. Its funds are very competitive, and they are more widely available in 401(k) and other retirement plans than those of its rivals.

Of these, I think the T. Rowe funds are the very best. T. Rowe embraces substantially more equity risk, especially in its Retirement 2015 fund (TRRGX). This fund's 70%/30% split between equities and fixed income seems to me an excellent balance to strike upon retirement.

If you accept the premise that you will need to draw 5% of your portfolio's value every year to supplement your other retirement income, it will have to grow roughly twice that much to compensate for inflation and the taxes you'll pay on withdrawals.

As they age, target-retirement funds themselves become more conservative. Five years from now, the 2015 funds will be allocating their assets the way the 2010 funds are doing it now. Fidelity Freedom 2005 (FFFVX) has already matured and is currently 49.4% cash and bonds.

The less equity risk these funds accept, the poorer their returns.

[Recently] the National Center for Health Statistics reported that average life expectancy in this country has risen to 77.9 years, from 69.6 years in 1955. But that's misleading, dragged down by accidental deaths and childhood disease. If you survive to 83, you are likely to live to 90.

And so, at age 65, your portfolio-planning horizon is 25 years. With even modest inflation, prices will double in that period; that's why you need enough equities to keep your portfolio balance growing as well.

You never want to end up on a fixed income.

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