Available now for a few years, target-date funds typically invest with a retirement-target date objective for the investor (e.g. Fidelity Freedom 2010 Fund, Symbol: FFFCX, which was designed for investors retiring in 2010). In most cases, these funds switch to more conservative asset classes, as the target date approaches.

They are appealing for those who don’t want to hire an investment advisor, aren’t knowledgeable enough to manage their own money or just don’t want to take the time to manage their assets. Target-date funds received a lot of press in the 2008 market downturn, because they, in more than a few cases, performed horribly. It’s very important, then, for investors to have some basic knowledge about target-date funds in order to be sure they are selecting a product suitable to their needs.

In testimony to Congress in 2009, John Rekenthaler, Vice President of Research for Morningstar®, discussed several areas investors need to pay attention to. As with any mutual fund, it’s important to pay attention to the fees charged. In Mr. Rekenthaler’s testimony, he noted that the average expense ratio for target-date funds was 0.69%, not bad for an asset-allocation fund. Yet, looking deeper, expense ratios ranged from a low of 0.19% to a high of 1.82%. Such a difference in fees can amount to staggering differences in the value of the funds you’ve invested in, over long periods of time.

Mr. Rekenthaler’s testimony also touched on the issue of the underlying funds that target-date funds invest in. If the target-date fund invests in funds of the same company that is marketing the target-date fund, it’s unlikely the target-date fund will perform as well as another target-date fund that seeks to use the best underlying funds available.

Another important feature of target-date funds is their “glide path”. Basically, a fund’s “glide path” involves how much is allocated to each asset class and how the allocations change as the target date is approached. Mr. Rekenthaler’s testimony noted: “The longer-dated funds tend to look quite similar. For example, the allocation to stocks for the 2040 funds in Morningstar's database runs from 80% as a minimum to 95% as a maximum. . Absent any mistakes from implementing the asset allocation, those funds will tend to perform fairly similarly.”

As the funds age, however, and approach their target date, the allocation to stocks varies significantly. This makes the risk of target-date funds with the same target date substantially different. Therefore, an investor thinking that all funds with the same target date would have similar risks, would be greatly mistaken.

A recent article in the Wall Street Journal by Anna Prior titled “Before Buying a Target-Date Fund ….” (Monday, June 7, 2010), pointed out some additional concerns to be aware of. First, she noted that you must also understand whether the fund is designed to just get you “to” retirement or “through” retirement. A “to” glide path will reach its most conservative allocation at the target date, while a “through” glide path won’t reach its most conservative allocation until 10, 20 or more years later, in order to provide inflation protection.

Another point worth noting is how broadly a target-date fund is diversified. Broad diversification can be good, as it can help lower volatility and increase returns. However, funds that try to juice returns by investing in riskier assets may turn out performing poorly.

The bottom line seems to be that while target-date funds can serve you well, you need to do your homework before selecting one. Those who pick a target-date fund because they don’t want to take the time to manage their own funds or don’t have the knowledge to do so may be unhappy with the results if they don’t seek some professional help.