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Some target-date funds miss in the market turmoil

Target-date funds, designed to be an all-in-one portfolio for retirement investors, have had a mixed record during the recent wild swings of the market.

In general, target-date fund families with larger allocations in fixed income investments compared to their peers fared better than those more focused on stocks recently, said Jeff Holt, a fund analyst at investment research firm Morningstar. But target-date funds with larger stock allocations have outperformed their peers overall during the six-year bull market.

For example, take two target-date funds designed for investors who retire this year: The Fidelity Freedom 2015 fund, which has more than 43 percent of its holdings in bonds and cash, lost 2.5 percent for the month through Aug. 27. While the Wells Fargo Advantage Dow Jones Target 2015 fund, which has a nearly 71 percent stake in bonds and cash, only lost 0.87 percent over the same period. Yet the Fidelity fund has a five-year annualized return of 7.6 percent compared with the Wells Fargo fund's 4.4 percent return.

Much of a target-date fund's performance is determined by the fund's "glide path." That's the formula a target-date fund uses to determine its mix of assets over time. All target-date funds get more conservative over time, shifting out of stocks and buying more bonds as they approach the target date.

Last year, the typical 2050 target-date fund, which had an average allocation of almost 90 percent in stocks and is designed for young investors planning to retire 35 years from now, gained about 1 percentage point more than the average 2015 target-date fund, which had about a 40 percent equity stake and is designed for investors at or near retirement.

The average asset allocation glide path's stake in stocks moved up by as much as 4 percentage points last year compared with 2013, according to Morningstar. Meanwhile, more target-date funds added alternative assets and some even began offering managed-futures strategies.

During the past month of market volatility, some target-date funds with small allocations in alternatives didn't fare much better than target-date funds without alternatives. "It raises the question if a small allocation to alternatives is worthwhile," Holt said.

Target-date funds are extremely popular, mainly because they are a default option in many retirement plans. Eighty-three percent of employers now offer a target-date fund, Deloitte found, up from 77 percent in 2013.

Assets in target-date funds reached $700 billion last year, according to Morningstar. Funds from Fidelity, T. Rowe Price and Vanguard account for more than 70 percent of all the assets in target-date strategies.

"Target-date funds do a much better job for investors than if they were left to their own devices," said Ralph Haberli, BlackRock's head of distribution for U.S and Canadian defined contribution retirement plans, explaining why target-date funds are attractive options for employers that sponsor retirement plans.

However, the problem for many investors is that there is no good way to benchmark their target-date fund's performance. S&P Dow Jones Indices offers a series of benchmarks for target-date funds, but they are not widely used by plan sponsors, Holt said, nor are they particularly useful if your target-date fund's glide path is different from the index's asset allocation.

"One of the biggest traps people fall into is that they compare their target-date funds to a simple equity return," Haberli said.

To make matters more confusing for investors, more employers are customizing their target-date funds in their retirement plans rather than using target-date funds offered by large mutual fund companies. Investment consulting firm Callan Associates found that 22.3 percent of retirement plans offered customized target-date funds last year compared to 11.5 percent in 2013.

It will take some effort for investors to find out if their target-date funds have good aim. "There is no clear cut way to do this. We look at the target-date fund series' peers," Holt said. "The most important thing is for investors to understand how their target-date fund is built." If you are worried about a target-date fund's performance, discuss its glide path and construction with your employer or fund sponsor.