Target date mutual funds are marketed to people investing to fund their retirement or a planned major event, like a child’s college education. The idea behind a target fund is that its investments are supposed to become more conservative as you reach the target date when you expect to draw on your investment, so that you are less likely to be selling at a loss or in the middle of a downtrend in the value of your investment. It sounds like a great idea in theory – an automatic investment plan designed to put your retirement savings on autopilot. In practice, it doesn’t always work that way – here are some examples and what they mean to you.

In 2008, which was obviously not a good year for stocks, the 2010 target funds from Fidelity, Schwab, T Rowe Price, and Vanguard lost 20 to 27% of their value, according to Morningstar, one of the more reputable monitoring and rating services. Why did these funds take such a beating? Did they put most of their money into super-risky stocks? No, but they did have 47 to 57% of their money in the stock market at a time when they were supposed to be within 2 years of their target redemption dates. While this would have looked very clever in a booming stock market, this investment strategy made these funds look rather foolish.

The premise behind the target fund concept is to gradually adjust the percentage of the fund allocated to stocks, bonds, cash, and other investments so that the mix becomes more conservative as you approach the date that you plan to sell these assets to fund a future expense. In the case of retirement, you should stagger the target dates over a 30 to 40 year period. The problem with some target funds is that they are just too aggressive in the years immediately preceding their target dates and if you just leave your investments on autopilot without checking to see that the fund is allocating your assets in a way that is consistent with your personal risk tolerance, you may be accepting risks that you did not intend to take.

According to the Employee Benefit Research Institute, over a third of people who participate in retirement plans have at least some of their retirement plan allocated to a target fund. Perhaps too many employers and fund companies push these funds on their employees as a simple solution to fund selection. Whatever the reason behind their popularity, understand that you don’t have to follow the crowd.

Most target funds are actually funds of funds, in which the target fund allocates varying percentages of its money in stock,bond, money market, and other mutual funds that they run. There’s no reason why you can’t do the same thing yourself, and set the percentages based on your own risk tolerance, adjusting the percentage allocated to stocks downward as you approach the target date, but generally not to zero. Even conservative funds oriented to providing income and capital preservation to retirees (Fidelity Freedom Income Fund and Vanguard Retirement Income Fund) had 20 to 30% of their money in the stock market last year.

Balancing Growth and Stability

Maintaining a balanced blend of assets, including not only a blend of types of assets but also a blend of conservative and less conservative assets, is more likely to give you a combination of growth and stability in your portfolio. For most people, managing your portfolio is not a business or a serious hobby, and if you set up a system for automatically limiting your losses, achieving necessary diversity and balance, and making adjustments to maintain your allocation policy (typically about 4 times a year), you can manage your portfolio with relatively little effort and without losing sleep over it.