The Best Target Funds

The bear market punished target-date retirement funds. From October 9, 2007, through March 9, 2009, funds geared for investors expecting to retire in 2010 tumbled 35% on average, while the average 2030 target-date fund plunged 51%. Meanwhile, Standard & Poor's 500-stock index lost 55%.

The Department of Labor and the Securities and Exchange Commission are now examining whether target funds misled investors about their risks. We agree that some target funds deserve to be singled out for sanction. But others still look like good, one-decision retirement funds. Really.

First, let's do some singling out. Oppenheimer's 2010 fund was the biggest loser in its class, shedding 54%, according to Morningstar. The Oppenheimer fund recently had 63% of its assets in stocks. Only AllianceBernstein's 2010 fund, with 65% of its assets in stocks, had a higher allocation among its peers. Allotting that much to stocks may be fine for some individuals approaching retirement, but a one-size-fits-all fund should steer a bit more conservatively (the average 2010 fund has 43% in stocks). What's worse, Oppenheimer Core Bond, an ingredient in the firm's target funds, plunged 36% in 2008. "Underlying funds made a big difference in performance of target funds," says Greg Carlson, a Morningstar analyst.

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Seven other 2010 funds lost more than 40% during the downturn. They include the offerings from AllianceBernstein, the American funds (which are usually first-rate (see American Funds Falter), Columbia, Goldman Sachs, John Hancock, Principal and RiverSource.

Some target-date funds have too little in stocks. A conservative allocation boosts performance during bear markets but hurts it in bull markets and is likely to hurt performance over long periods. Wells Fargo's 2010 fund, which has just 26% in stocks, lost only 19% during the bear market, and AIM Independence 2010 fund , which has only 28% in stocks, fell just 28%. Unless you're very wealthy, having so little in stocks won't likely support a retirement that could easily last 30 years.

The SEC is considering, among other reforms, whether it should prescribe stock and bond allocation ranges for target funds. All 2010 funds, say, might be required to have between 40% and 55% in stocks.

Bear-market performance of 2030 funds clustered tightly. Leading the losers again was the Oppenheimer fund, which fell 57%. So did AllianceBernstein's. But that's only six percentage points worse than the average 2030 fund's loss. Investors in these funds are presumably more than 20 years from retirement, giving them plenty of time to recover. That is especially true for those who have continued to invest regularly.

Money flowing into target-date funds surged after the federal government allowed employers in 2006 to make them default choices for employees who didn't want to make selections for their 401(k) accounts. The names differ slightly among fund firms, but they almost always end with a year. You pick the fund with the date closest to the one in which you expect to retire. (So, for example, you can invest in Vanguard Target Retirement 2010, 2015 and so on.) Fund companies then allocate investments in each fund in a way that they think makes sense for people who are that far from retirement. The funds, which typically invest in other funds offered by the same company, gradually grow more conservative as the target date nears.

The government changed the rules at what turned out to be an unpropitious time -- not long before the start of the worst bear market since the Great Depression. Previously, many employers had designated low-risk, stable-value funds or even money-market funds as default options.

The biggest players. The lion's share of target-date money is in three big no-load shops: Fidelity, T. Rowe Price and Vanguard. Fidelity holds half the target-date money, and Price and Vanguard account for another 30% between them. A brief look at each sponsor's 2010 and 2030 funds follows:

When it comes to asset allocation, Vanguard is the most conservative of the three, though only slightly more conservative than Fidelity. Vanguard Target Retirement 2010 (symbol VTENX) recently held 52% of its assets in stock funds and the rest in high-quality bond funds. Fidelity Freedom 2010 (FFFCX) had 52% of its assets in stocks and 5.5% in high-yield, "junk" bond funds (whose risk profiles are similar to those of stocks). Meanwhile, Vanguard Target Retirement 2030 (VTHRX) had 84% in stocks and the rest in high-quality bonds, while Fidelity Freedom 2030 (FFFEX) held 78% in stocks and 8% in junk bonds. Like stocks, junk bonds suffered last year.

Unfortunately, the Freedom funds don't use some of Fidelity's better stock funds, such as Contrafund (FCNTX) and Low-Priced Stock (FLPSX). Moreover, poor performance of underlying funds hurt during the bear market. Fidelity's 2010 fund lost 37%, and its 2030 fund tumbled 52% -- both worse than their category averages. The annual expense ratio for the 2030 fund is 0.76%, a figure that reflects the costs of the underlying funds (none of the big three tack on additional management fees beyond the costs of the funds they hold). The expense ratio for the 2010 fund is 0.64%.

Vanguard does what you'd expect: Its target funds invest in low-fee Vanguard index funds, helping to hold down costs. Annual expenses for the 2010 and 2030 funds are each just 0.19%. The 2010 fund lost just 33% during the bear market, while the 2030 fund surrendered 50%. The funds were helped by the relatively good performance of index funds during the bear market and the absence of junk bonds.

T. Rowe Price, the most aggressive of the three, had the worst bear-market numbers. T. Rowe Price Retirement 2010 (TRRAX) plunged 39%, and Retirement 2030 (TRRCX) sank 52%, the same percentage as Fidelity's 2030 lost. Price allocates more to stocks than the other two-58% in its 2010 fund and84% in its 2030 fund. The funds also hold junk bonds -- 5.6% and 4%, respectively. Long term, I like these allocations. Plus, Price puts the best of its funds into its target products, including Mid-Cap Growth (RPMGX) and Mid-Cap Value (TRMCX), both superb funds. Expenses are 0.61% for the 2010 fund and 0.72% for the 2030 fund.

Bottom line: You won't go far wrong with target funds from any of these three families -- unless the bear market makes an unwelcome comeback. If you like actively managed funds, choose from Price's menu. If you're an index maven, target Vanguard's retirement funds.

Steven T. Goldberg (bio) is an investment adviser.