Think you can plunk down a client's money on any target date fund as a low-risk way to accumulate retirement savings?
Think again.

Target date funds use asset allocation and rebalancing strategies. Often, they aid an asset-holder's transition from a strategy of capital growth to one of capital preservation by gradually shifting funds from stocks to fixed-income instruments such as bonds and cash.

There are 300 target date funds, which together hold assets of almost $200 billion, according to the Investment Company Institute. Not all are alike. The majority have not been around for even three years, according to Morningstar Inc., Chicago. So they have no long-term track records.

Often, they fall into three groups, named for the date ranges in which they will likely reach fruition: "2000-2014," "2015-2029" and "2030-plus." The portfolio manager changes the mix of stocks, bonds, cash and other assets faster or slower as the fund approaches its target date, making changes according to the fund's "glide path." Typically, this path continues after the funds hit their target dates, as the allocation of stocks continues to decline during the investor's retirement years.

Thanks to the Pension Protection Act of 2006, target date funds have become a default option in 401(k) and 403(b) defined contribution plans. Many plan sponsors want investment companies to customize them for their plans by setting up "collective investment trusts"-products that are similar to mutual funds but only offered through qualified retirement plans. With such tailor-made trusts, investment companies can lower costs and offer a wider range of alternative investments in real estate, REITs and emerging-market securities. These newly formed collective trusts use more sophisticated asset allocation and glide-path strategies.

"Generally [target date funds] are living up to expectations," says Chris Lyon, partner with the employee benefits investment consulting firm Rocation in Norwalk, Conn. "There are a lot of new products available, so it is difficult to evaluate them. But the funds are a lot better investment for the typical plan participant."

Unfortunately, plan participants have no option when it comes to selecting the investment company that runs the target date funds in the plan. Apart from 401(k)s and 403(b)s, Lyon says that financial advisors also can add value to client services by helping them select the right target date fund for IRAs, Roth IRAs, IRA rollovers, SEPs and SIMPLE plans.

But they must narrow the field from a vast array of options. Variables that must be considered include: the track record of the overall fund group, the stability of management, the method of allocating assets, a fund's expenses and the characteristics of the individual mutual funds that make up the target date fund's portfolio.

"Their asset allocations differ as well as the glide paths," says Morningstar analyst Greg Carlson. "Some funds are more aggressive early on, while others may be more aggressive in later years."

Carlson says that funds use similar methods to allocate assets. They consider the mean variance approach, based on the correlation among investments, expected rates of return, economic trends and stock and bond fundamentals.  

But diversification by investment style can differ greatly. Some funds may be more heavily weighted for example, in large-cap growth stocks, while others might be positioned in mid-cap and small-cap sectors. There are also differences in the weightings of international positions.

"Differing asset allocation policies and expense ratios ought to lead to significant differences in performance over the long haul," Carlson says in a recent report. "We wouldn't expect sharp performance differences over shorter periods-particularly in 2007, when stocks have barely outpaced bonds. Yet a close look shows exactly that."

For example, in the 2015 to 2029 target date portfolios, Carlson says that the Franklin Templeton 2025 Retirement Fund gained 9% in 2007, while the Putnam Retirement Ready 2025 Fund gained just 1.5%. Reason: Franklin had a much larger weighting in mid-cap stocks than Putnam.

Carlson adds that more aggressive target date funds typically sport higher expense ratios. And some funds' asset allocation tactics cause them to get whipsawed over the short term. Some funds also boost exposure to asset classes that have done well in the past or cut back on stocks that have declined in value only to find such securities then moving in the opposite directions.  

Joe Nagengast, president of Target Date Analytics in Marina del Rey, Calif., says that financial advisors must examine more than a fund's expenses. They must also evaluate how rapidly the fund changes its mix of stocks, bonds and cash as it nears its target date. One fund's 2010 asset allocation mixes can help you determine what the longer target date funds will have in stocks and bonds at their target dates as well, since the longer-term funds should have the same mixes two years out, since they have the same glide path in transitioning from stocks to fixed-income investments. But there are disparities. Currently, 2010 target date funds' stock allocations range from 20% to 70%.

"You see the biggest discrepancies in short-date target funds," Nagengast says. "The funds claim they have the same purposes-to provide stability for investors. But some funds, like AllianceBernstein and T. Rowe Price, have over 60% in stocks when they are just two years away from their target dates. This could be too aggressive for many people nearing retirement."

Nagengast adds that you do not see big disparities in asset allocation mixes of longer-term target date funds in the 2030 to 2050 range. It is only when they near their target dates that the stock and bond allocations can significantly differ.

Over the long term, Nagengast believes that all target date actively managed funds will underperform their benchmarks because of fund expenses. "My criticism is couched with the understanding that most people are better off in a target-date fund [in their 401(k) or IRA]," he says. "It is a better solution than doing it on their own."

Nagengast says that nearly 90% of the assets in target date funds are held by Fidelity Investments, T. Rowe Price and Vanguard, all of which are major players in the 401(k) arena. But these fund groups take different approaches to portfolio management.

Fidelity Freedom 2020 Fund uses 25 other Fidelity Funds. At the target date, 50% of the portfolio is invested in stocks. Then stock positions are gradually reduced. The expense ratio is 76 basis points.

The T. Rowe Price Retirement 2020 Fund has 60% in stocks when it hits its target date, contained in six to eight T. Rowe Price funds. The stock positions are gradually reduced. The expense ratio is 69 basis points.

The Vanguard Target Retirement 2020 Fund invests in seven Vanguard index funds. At the target date, the fund will have 50% in stocks then gradually reduce its positions. The expenses run just 20 basis points.

There is no free lunch with these portfolios. If research on these funds is any indication, financial advisors themselves must make sure that the risk level of the mutual fund matches a client's tolerance for risk based on his or her investment time horizon.

An April 2008 working paper by Francisco J. Gomes, finance professor at the London School of Business, found that target date or life cycle funds that do not match the risk tolerance and investment horizon of investors may not deliver as much money as a retiree expects. The paper, Optimal Life-Cycle With Flexible Labor Supply: A Welfare Analysis of Life-Cycle Funds, is available at the National Bureau of Economic Research (http://www.nber.org/papers/w13966).

Other research, published in the 2007 Financial Services Review by Harold J. Schleff, economics professor at Lewis & Clark College, found that investors would do just as well investing regularly and passively with a mix of stocks and bonds during the accumulation stage.

The $64,000 question: What should clients do with all the money piling into target funds when they finally hit their target dates?

Garth Bernard, actuary and partner with Retirement Income Solutions Enterprise Inc. in Roswell, Ga., says most people often cash out. So it is important for a financial advisor to assist clients in setting up a retirement income portfolio based on cash flow needs and longevity risk. The advisor can analyze a retiree's source and use of funds and cash flow to segment their investments.

"People tend to cash out their target-date funds at the target date," Bernard says. "Then they have to make other investments that correspond to their cash-flow needs during retirement."

Bernard says that an advisor should seek solutions by looking at a number of investment options. Some money can be invested in high-dividend-paying stocks, corporate bonds, REITs, preferred stocks and mutual funds for both income and some growth. He also suggests investing part of a target date fund's proceeds in an immediate annuity to meet a retiree's fixed costs, such as food, clothing, shelter and medical needs for life. A financial advisor could ladder immediate annuities, so that the income stream keeps pace with inflation. The rest of the investment may be put in stocks and other securities for growth to keep pace with inflation.