What's wrong with target date funds?

The concept seems simple enough; pick a retirement date, select an off the shelf portfolio from a brokerage and sit tight. Let the brokerage determine the funds in the portfolio and have them adjust it accordingly ratcheting down your risk profile as you reach retirement.

Any confusion regarding asset mixes or a confusing array of mutual fund choices is instantly eliminated. Funds are named by year and are spaced 5 years apart. making it easy to select a target portfolio.

So what can possibly be wrong with this approach?

Too often, investors don't use target date funds properly, and you have to wonder whether one fund can really be appropriate for everyone who retires in a given year. The asset allocation of a particular fund won't suit the risk tolerance of all individuals who plan to retire in that year.

Each fund family is different and each investor is different. I might want to be as conservative as possible as I get closer to retirement and my fund might still have 30 percent in stocks, when I'd rather prefer to be 100 percent in bonds. People have to understand what they're buying, and many people don't look under the hood.

Another potential problem is that investors aren't given enough information regarding the philosophy behind target date funds and how they should invest their money.

The concept is one-stop shopping, but people don't do that. About 90 percent of the people who have money in the fund have it in there incorrectly. It's just another fund that they put their money in. They might have money in six other funds -- growth, value, etc., and then maybe 15 percent in target date.

While that problem might be fixed by better educating employees and other investors who consider these funds, another situation might be more perplexing to consumers. The asset allocation in a specific target date fund can vary from one firm to another.

Look at the 2020 target date funds from Fidelity, T. Rowe Price and Vanguard, and you'll see quite a bit of difference among them in asset allocation.

	Cash	Stocks	Bonds	Other
Fidelity Freedom 2020 Fund	4.76%	69.43%	17.85%	7.97%
T. Rowe Price Retirement 2020 Fund	4.75%	76.48%	18.03%	0.74%
Vanguard Target Retirement 2020 Fund	1.31%	70.22%	27.65%	0.82%
Data from Google 9/27/07

T. Rowe Price looks to be the most aggressive of the three with more than 76 percent of the portfolio in stocks, a mix the company finds appropriate for someone 13 years from retirement.

Above all, for the level of risk, consumers should check the performance of any target date fund to see if it at least matches the performance of a benchmark index or category.

Another potential weakness is that most fund companies will use a roster of their own funds, some good and some not so good. Moreover not every company has great funds across the board. Fidelity may have a fantastic large cap value fund while T. Rowe Price excels at small cap.