Not Quite a Bull’s Eye

Imagine an investment that magically adjusts itself over time to reflect your financial needs–as you approach retirement or as your child gets closer to college. With this miraculous tool, your only duty would be to add money regularly, and when you’re ready to tap your funds, you’d have a tidy nest egg to fund your needs.

If that sounds too good to be true, it is–sort of. These “autopilot” investment vehicles are called target-date or lifecycle funds, and they’ve become increasingly popular with investors who prefer a hands-off approach to saving for retirement or college. Target-date funds gradually shift their holdings from aggressive, stock-heavy portfolios to a more conservative, bond-focused stance as time passes. They’re often featured as choices for 401(k) investments and 529 college-savings plans.

Investors are signing on in droves. As of June 2008, investors held $205 billion in target-date funds–up from just $9 billion in 2000, according to the Investment Company Institute, which tracks mutual fund activity. Nearly 90% of assets in these funds are held as part of retirement accounts, according to the ICI.

Though lifecycle funds seem to alleviate concerns about maintaining a properly balanced portfolio, investors should be wary of relying on a generic formula to meet their unique retirement needs. “You would think it would be a great idea on the surface,” says Ivory Johnson, director of financial planning for Scarborough Capital Management in Annapolis, Maryland. “Its one-stop shopping but it does not account for the current environment.”
Investors who entrust their retirement portfolio to a lifecycle fund often do so because they’re busy, confused, or overwhelmed by investment choices.

he biggest problem with target-date funds is they’re general templates that don’t reflect an individual’s needs, tolerance for risk, and specific circumstances such as the obligation of caring for an elderly parent or a grandchild, says Johnson. And even if your retirement plans remain unchanged, there’s no guarantee that the economy will cooperate. “If you own bonds and interest rates go up, you’re going to lose money,” Johnson says. “So what sometimes seems conservative isn’t.”

Using a target-date fund to save for future college expenses offers less potential for shortfalls. That’s because the cost for four years of university expenses is easier to estimate than decades of uncertain retirement costs and expenses. Rodney and Marion Wilson of Richmond, Texas, expect to have $40,000 to $50,000 for each of their two children when Angel, 16, and Joseph, 13, are ready for college. The Wilsons opted for a target-date 529 college saving program when they began investing seven years ago. They’ve made consistent monthly contributions and have been pleased with its average 8% annual return. The Wilsons, who own a busy dialysis clinic business, say the lifecycle funds’ self-adjusting nature was a big draw. “The most appealing part was not having to manage it for yourself,” says Rodney. “Being maintenance-free was the best option for us.”

When you’re choosing retirement investments, think carefully about whether a lifecycle fund is right for you. Consulting a financial planner might help you gauge your tolerance for risk; allow that to inform your specific post-retirement plans. If a target-date fund is already the cornerstone of your retirement savings, don’t feel you’re stuck. You can change your strategy as needed. Do whatever you can to make sure your plan is on the mark.

This article originally appeared in the April 2009 issue of Black Enterprise magazine.