No-Brainer Investing Carries Risks

The problem: You just don’t have time, the inclination or financial experience to manage your retirement investments on your own.

The solution: Invest in a “target-date” or “life-cycle” mutual fund, letting the pros deal with tricky issues like choosing the best of stocks and bonds. Except that this solution doesn’t always work in the ways investors expect. Many were shocked when funds they thought were pretty safe racked up huge losses in 2008.

These funds have become enormously popular, especially in 401(k)s and similar workplace retirement plans that cater to people who don’t want to sit down every year to move money from one holding to another.

The typical target-date fund puts most of the young investor’s money into stocks, hoping for big returns, and gradually shifts it to bonds as the retirement or college-starting date approaches and safety becomes more important.

In 2006 the U.S. Department of Labor gave 401(k) plan administrators permission to use target-date funds as a “default” option for new plan members who did not choose another investment. About 96% of plans that automatically enroll new employees use target-date funds as the default, according to a study by the Special Committee on Aging of the U.S. Senate.

But the study found that asset allocations vary widely even among funds with the same target date, so that some funds are far riskier than others. Among funds with a 2010 target date, for example, the stock portion varied from 24% to 68%. Guidelines used in the Dow Jones Target Date Indexes (Stock Quote: DJ) say a fund should have just 28% of its assets in stocks when the target date arrives, while the average 2010 fund has 45% in stocks, the report said.

The result is wide variation in performance. The study found that the Deutsche Bank DWS Target 2010 Fund (Stock Quote: KRFAX) lost just 4% in 2008, while the Oppenheimer Transition 2010 Fund (Stock Quote: OTTAX) lost 41%.