Sponsored by:

For Funds, Pay Attention to the Fine Print

Just a couple words can separate two very different investments

   
For Funds, Pay Attention to the Fine Print

The hit song might claim that “Girls just wanna have funds,” but really, funds are a great option for any investor — especially those just starting out.

youngInvestorsB.png For Funds, Pay Attention to the Fine PrintThat is how the song goes, right?

Anyway, I’ve previously encouraged young investors to start with funds for their ease of use and the wide exposure they offer, among other perks. But while funds (mutual or exchange-traded) are relatively easy to digest — and while you shouldn’t get too weighed down by the never-ending complexities of the market — one must also be careful not to oversimplify and thus overlook important details, such as the fine print.

Just last week, for example, I pointed to target-date funds as an appealing option for those intimidated by the idea of properly allocating a 401k.

These funds are essentially retirement savings on autopilot because you simply pick the fund with the year closest to your planned retirement and the rest of the work is done for you. A 21-year-old planning to retire at age 65, for one, would want to be in the Vanguard Target Retirement 2055 Fund (MUTF:VFFVX). Whoever is running the fund adjusts the exposure to stocks, bonds and other assets in relation to how much time there is until retirement. The closer you are to the golden date, the more conservative the investments get.

Still, it’s important to note that all target funds are not created equal — something InvestorPlace contributor Aaron Levitt recently pointed out to me.

While two funds might have the same exact retirement date, there are two general breeds of target-date funds — “to” funds and “through” funds — and the distinction is important.

A “to” fund is designed to get you to your retirement date. Once you get there, the allocation will be extremely conservative — mostly bonds or cash. A “through” fund, on the other hand — which the Vanguard option is — continues to hold a larger stock allocation even past the date as a way to keep generating higher returns.

Simply put: The first option reduces market risk, but also reduces the longevity of your savings. The second option does the opposite.

Of course, most funds don’t explicitly use “to” vs. “through” terminology, but you can tell based on its objectives or glide path. For example, Vanguard’s fund description notes that its target-date funds “continue to adjust for approximately seven years after (the retirement) date.”

Similarly, the TIAA-CREF Lifecycle 2055 Fund (MUTF:TTRLX) also uses a “through” strategy, saying that “the allocation to equities continues to decline after the lifecycle fund reaches its target retirement date, ultimately reaching an allocation of 40% equity and 60% fixed income about 7 to 10 years later.”

A good gauge: If your fund will end up being 30% or 40% invested in stocks even after you retire, odds are it’s a “through” fund.

Franklin funds like the Franklin Templeton 2045 Retirement Target Fund (MUTF:FTTAX), on the other hand, have a different ring to them: “At the landing point (reached at target date), the fund reaches its most conservative allocation; thereafter, this strategic asset allocation will generally not change.”

Once again, over the longer haul, this probably will not generate nearly as much in returns, and probably won’t be enough if you expect to live to age 90. But it is less risky.

In the end, there’s no black-or-white answer as to which option is better — it varies person to person. The important thing for you is to make an informed decision regarding which kind of fund to choose, or to realize which kind of fund you are already in and adjust accordingly.

If you are in a “to” fund, for instance, you probably want you shift your assets out of it within the first five years after reaching your retirement year, unless you plan on spending all that money anyway. If you are in a “through” fund, be aware that your allocations will be riskier, even once you hit your target retirement date.

Still, as I said earlier, if you’re just getting started, target funds remain a good place to start. You don’t necessarily have to know all the ins and outs of every fund, as most of the work is done for you — that’s why you’re paying a fund manager in the first place.

Just make sure you do your fair share of the homework to realize exactly what kind of work is being done.

As of this writing, Alyssa Oursler did not hold a position in any of the aforementioned securities.

Like what you see? Sign up for our Young Investors e-letter and get practical investing advice delivered to your inbox every week!


Article printed from InvestorPlace Media, http://investorplace.com/2013/04/for-funds-pay-attention-to-the-fine-print/.

©2014 InvestorPlace Media, LLC

Comments are currently unavailable. Please check back soon.