Target Date mutual funds are meant to be “set it and forget it” type funds, where you pick the year you think you will need the money (for retirement, education expense, etc) and allow the fund to automatically adjust its risk profile so that it becomes more conservative as the target date approaches.  These funds are often used in 529 accounts for education savings, in 401k plans, and by people who just don’t want to think much about investing.  They seem pretty easy to use, but as with most things when it comes to investing, there are some things to watch out for.

First of all, Target Date funds assume they are the only investment you own.  This means they will contain an allocation of U.S. and foreign funds, large-cap and small-cap funds, bond funds, etc.  This is fine when it really is the only investment for a particular objective (e.g. education savings).  However, if the Target Date fund is combined with other investments, which is often the case when it is part of a retirement program, it can create a lot of difficulties in controlling an overall allocation.  The most common problem I’ve seen is that portfolios often become over-weighted with large cap stocks.

Another issue is that one company’s Target Date Fund for a particular year may have a very different risk profile than another company’s Target Date Fund with the same target year.  According to Investment News, there are currently 2010 target funds with a stock allocation of 20%, and others with closer to 65%.  The 2010 funds with the most aggressive allocations are down more than 30%, which is not good if you need the money next year.

If you are using Target Date funds, the important thing is to understand how it fits with other investments in your portfolio, and to make sure that the fund’s risk profile fits with your own risk tolerance.  Holding a fund with 65% stocks when you need the money next year is not going to fit well with most investor’s idea of risk.