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The One Fund Solution for 403(b) and 457(b) Participants?
When it comes to participating in a 403(b) and/or 457(b) there are essentially two ways to go: do it yourself or use an advisor. The sheer complexity of investing can send even the savviest saver running for advice. The mutual fund industry believes it has the cure for the aspiring do-it-yourselfer looking for a simple, low-cost option for saving for retirement.
  Known by a variety of names — age-based, life-cycle, target-date retirement — former Marine and current T. Rowe Price portfolio manager Jerome A. Clark, CFA, may have the best phrase to describe the increasingly popular breed of mutual fund which greatly simplifies saving for retirement. He calls it "fire and forget." It's a military expression that describes a weapon that automatically does what it is supposed to do allowing a soldier to return to safety. This is exactly how target-date retirement funds work. Investors simply choose an estimated retirement date in the future — say 2027 — and select the target-date retirement fund that corresponds most closely to this date. Fund operators take it from there as they guide the fund like a missile to its ultimate destination: retirement.
Asset Allocation Made Simple
Aimed squarely at retirement savers, these funds make the most critical and difficult part of retirement saving — asset allocation — simple. Studies indicate that more than 90 percent of a portfolio's long-term return is the result of asset allocation — the process of distributing investments across various asset classes (stocks, bonds, cash) in an attempt to moderate the inevitable ups and downs of investing. Studies also indicate that investors are loath to alter initial allocation, meaning that most investors retire with the exact same allocation as the day they began. To prevent such a scenario which courts disaster, target-date funds automatically adjust asset allocation over time. The farther an investor is from retirement, the more weighted the fund is toward equities (stocks). The fund automatically becomes more conservative as the target retirement date approaches. For example, in 2006 the T. Rowe Price Retirement 2030 fund was weighted 91% stocks and 9% fixed income investments, while the T. Rowe Price Retirement 2010 fund was weighted 66% stocks and 34% fixed income investments.
Taking the Emotion Out of Investing
Fund manager Ren Cheng has overseen Fidelity's target-date Freedom Funds since 1996, and says the beauty of the target-date approach is that it takes the most volatile aspect of investing — emotion — out of the equation. "The average investment decision is based on emotion, not reality," Cheng said. To underscore the negative impact of emotion he points to a recent study by market research firm Dalbar, Inc. which reported that from 1984 to 2003 the average investor earned a paltry 2.57% annually. When factored for inflation (3.14%) investors actually lost money. These results contrast sharply with the 12.22% the S & P 500 index (basically the 500 largest American companies) returned during this period. Why the disparity in performance? "When the market went down investors pulled their money out of equities (stocks) and went into bonds," said Chen. "When bonds declined it meant the investor experienced two losses in one cycle."
Growing Demand
Wells Fargo Bank and Fidelity were early pioneers of the target-date approach. In fact, Chen has been involved since 1994 when Fidelity first began working on the concept. Today the Freedom Funds lineup (2000, 2005, 2010, 2015, 2020, 2025, 2030, 2035, and 2040) boasts more than $25 billion in assets under management. T. Rowe Price launched its initial lineup (2010, 2020, 2030, and 2040) in October 2002 and the reaction has been strong. "We hoped to have $100 million to $200 million under management by the end of 2003," said Clark, who manages T. Rowe Price's retirement funds. "Instead we had half a billion." This figure doubled less than a quarter later as T. Rowe Price rolled out additional funds to cover the dates 2005, 2015, 2025, 2035, and 2045. In late 2003, the Vanguard Group introduced its lineup (2005, 2015, 2025, 2035, and 2045) of target-date funds and within six months had attracted more than $720 million.
Allocation Varies Among Vendors
While all target-date funds operate in a similar fashion, allocation ratios vary. T. Rowe Price takes the most aggressive approach to allocation. "We are different from everyone else," Clark said. "We are not focused on retirement but the 30 year distribution period that follows retirement."
The following information is from year 2008:
T. Rowe Price Retirement 2035 fund: stocks 88% - fixed income 12%
Fidelity Freedom 2035 fund: stocks 82.5% - fixed income 17.5%
Vanguard Target Retirement 2035 fund: stocks 90% - fixed income 10%
  For complete information on asset allocation consult each company's website.
What Happens When the Target Date is Reached?
There is some variance among vendors, but generally the fund remains open for about five years as it gradually reduces stock exposure until its allocation mirrors that of a static (fixed) retirement fund (typically a 20% stock/80% fixed investment mix). At that point the fund is rolled into a static retirement fund operated by each vendor. T. Rowe Price takes a more aggressive approach that moves investors from a 55% stock/45% fixed investment mix at target date, down to a 20% stock/80% fixed investment mix over a 30 year period. If desired an investor can choose to be transferred to a static retirement fund (40% stock/60% fixed investment mix) at any time. T. Rowe Price cites the example of a 65-year-old retiree and an 85-year-old retiree. Manager Clark believes these investors have different time horizons and should have the choice of different retirement allocation options.
Fees Less Than Average Mutual Fund Cost
Target-date retirement funds offered by T. Rowe Price, Fidelity and Vanguard are all no-load and charge fees that are significantly less than the average mutual fund charge of 1.4 percent (Morningstar).
The following information is from year 2008:
T. Rowe Price Retirement 2035 fund charges 0.74 percent.
Fidelity Freedom 2035 fund charges 0.81 percent.
Vanguard Target Retirement 2035 fund charges 0.19 percent.
  It is important to note that target date products are often funds made up of other mutual funds. Fidelity and T. Rowe Price mostly employ actively managed products, while Vanguard relies mostly on index funds. For complete information on fund composition and fees consult each company's website.
Appealing Product for Plan Sponsors
Plan sponsors often lack money to provide retirement plan communication and financial education to employees. With target-date funds, plan sponsors can rest assured that they are providing a simple, cost-effective way for most employees to save for retirement that ensures the most crucial aspect of saving for retirement: proper allocation. A growing number of employers are using target-date funds as the default contribution and automatically enrolling new hires in age-suitable funds. "It makes perfect sense," said Fidelity vice-president market manager Tim Rouse. "The employer knows they are OK as far as proper asset allocation goes."
Appealing Product for Participants
"They appreciate the logic of it," said T. Rowe Price's Clark. "It makes sense." Vanguard's John Woerth echoes this sentiment: "These funds are designed for investors seeking a simple solution to their retirement needs whether they are in the accumulation, transition or withdrawal phase."
Designed to be Sole Investment in Portfolio
Because target-date funds promise diversification in a single fund they should be the sole investment in a portfolio. Mixing target-date funds with other funds can throw an investor's portfolio out of proper diversification. For example, if a person with a 2015 target-date mutual fund also owns stock funds, they may be overweighted in stock holdings, especially for an investor less than a decade from retirement. This isn't to say investors should never combine target-date funds with other funds, but if they do they must factor all of their holdings to determine if they are properly allocated for their investment situation.
No Single Approach is Suitable for All Investors
While no single approach is suitable to all investors, beginners and experts alike may appreciate the pure simplicity of the target-date approach which is important when so much about investing can be confusing: stocks, bonds, cash, value, growth, risk, allocation, small-cap, large-cap, sector fund, sub account, front-end load, back-end load, surrender charge, M & E, 12b-1, etc., etc., etc.

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