Funds lazy investors love

Funds that adjust your asset allocation as you get older are finally catching on, writes Fortune's Jon Birger.

By Jon Birger, Fortune senior writer

(Fortune Magazine) -- Target-date funds are the rare eat-your-vegetables financial product that have actually caught on with investors. These funds hold a mix of stocks and bonds that changes as an investor's anticipated retirement year approaches. For instance, the equity allocation of the Fidelity Freedom 2045 shrinks from 90% in 2005 to 40% by 2045.

These offerings were originally aimed at disengaged 401(k)ers -- "the two-thirds who describe themselves as unprepared to make investments and who don't view investing as fun," observes Tom Fontaine, an AllianceBernstein research director who helps manage Alliance's target-date offerings.

WHERE TO FIND THEM
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These companies offer an array of excellent target-date funds.
Vanguard
877-662-7447
Alliance-Bernstein
800-227-4618
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Yet the category has taken off with active investors too -- folks tired of jumping from fund to fund in a costly search for investing nirvana. Morningstar says the number of target-date funds has soared from 39 in 2002 (with $15 billion in total assets) to 248 today (with $171 billion).

Most of these funds have been sold through company 401(k) plans. For many plans, they're the default option for new enrollees. The one downside is that some fund companies treat target-date investors like captive audiences. The Aim Independence, John Hancock2 Lifecycle, MFS Lifetime, and Sun-America High Watermark all inflict expense ratios in excess of 2%.

If you're shopping for a target-date fund for your IRA, your choices expand. Just don't pick a fund because it has the best recent returns. Remember, you're buying a product you intend to hold for decades, not years, and history tells us that today's fund heroes are often tomorrow's goats.

Our suggestion: Choose funds that have structural advantages.

A case in point is Vanguard Target Retirement. Vanguard's 2040 fund boasts a 0.21% expense ratio, which is three-quarters of a percentage point below the category median. With compounding, that edge could eventually put an extra $100,000 into a $20,000 rollover IRA.

The AllianceBernstein Retirement Strategy funds maintain above-norm equity allocations longer than most, recognizing that the generally higher returns on stocks can do more to grow your nest egg in later years (when your portfolio is bigger) than when you're just starting out.

Another Alliance advantage: The underlying stock, bond, and real estate funds aren't preexisting funds, which means target-date investors' returns won't be harmed by other investors moving in and out at inopportune moments.  Top of page