When Target-Date Funds Miss the Mark

That, in theory, is your only decision. Just invest regularly in that one fund, and it does all the rest -- magically rebalancing itself until retirement day.

So much for theory.

In practice, these retirement funds aren't always what they seem. You may believe you're getting a "one-decision" fund. But because no two funds are alike, it's hard to know what's been decided. Fund companies have been rolling out a greater number of target-date mutual funds lately, with many of them ending up in 401(k) plans.

Imagine two people who work at adjacent desks, and both plan to retire in 2030. Three years ago, one of them put $10,000 into the T. Rowe Price 2030 Retirement fund (TRRCX). Today, she's pretty happy. That money has already grown to nearly $15,000. The T. Rowe Price fund is a top performer in that period, earning 14.36% a year.

Her colleague also put $10,000 into a 2030 retirement fund three years ago, but she chose the 2030 NestEgg fund (NEHPX) run by American Independence funds. Today, she's got just $13,000 -- almost $2,000 less.

This isn't an isolated case. Look at the performance data tracked by Lipper, and something surprising jumps out. Target-date funds are all over the place. So far this year alone, some year-2030 funds are up 10.3% while others are up a paltry 4.7%.

Even more surprising: This holds true even for the fundholders who are retiring soon. You would expect all "2010" funds to be playing it safe. The reality? The T. Rowe Price 2010 fund (TRRAX) is up 37% over the past three years. The one from Wells Fargo (WFOCX) is up less than half as much: just 16%.

What's going on?

In fact, these are fairly different funds trying to do different things. Both Wells Fargo and American Independence defended their funds' performance, pointing out that these are meant to be very conservative investment vehicles. That means fewer stocks, more bonds. It also means, depending on the firm, little or no exposure to riskier asset classes such as international equities, emerging markets and high-yield bonds.

As a result, you would expect these funds to fall behind their competitors when markets are rising, as they have for the past few years, but to prove much safer investments if things turn volatile. (Wells Fargo also pointed out their funds were "relaunched" a year ago. American Independence says it will be making some changes next month.)

Eric Rubin, president of American Independence funds, said his NestEgg funds are designed to be an appropriate "default option" in a company's 401(k) plan. Right now, he notes, the default option is often a money-market fund. That means low returns and virtually no risk. Rubin argues his funds offer much better long-term returns for minimal extra risk.

Fair enough. And if the aim is to coax unsophisticated long-term investors away from cash, he's doing them a big favor. Cash is a terrible long-term investment.

But that makes his funds a very different vehicle from those offered by companies such as Fidelity and T. Rowe Price, which are much more heavily weighted toward equities and other asset classes. These are seeking to offer greater long-term returns in exchange for greater volatility. They have, inevitably, done best over the past few years.

Jan Dahlin Geiger, a certified financial planner in Atlanta, says most target-date funds are too conservative anyway. "Most of them basically have you dying 10 or 15 years after you retire," she says. As a result, they move too much money into bonds too early. Most people, she says, should plan to live to be 90 or 100 years old, and that means keeping more stocks in their portfolio for longer.

Geiger believes there are better options than a target-date fund. But she says you should add 10 or 20 years to the target date if you do invest in one.