Customizing Cookie-Cutter Funds

By Eleanor Laise, The Wall Street Journal

Last Update: 9:38 PM ET Nov 20, 2007

Target-date mutual funds have soared in popularity because they make saving for retirement simpler. Now a growing number of people and some employers are battling the funds' one-size-fits-all approach by souping them up.

Target-date funds are meant to be the only investment a person needs to save for retirement. The funds, already popular, recently got a big boost from new Labor Department regulations. They typically hold a mix of stocks and bonds and grow more conservative as they approach the target date, which generally matches investors' expected retirement date. Some people complain that everyone retiring in the same year gets the same treatment -- people who expect to retire in 2020, for instance, will mostly all get placed into the same holdings with similar amounts of stocks, bonds and other investments.

Moving Target

More individuals and employers are custom tailoring their target-date funds.

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Off-the-shelf products don't suit everyone's savings goals and risk tolerance.
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Some people want a more aggressive investment allocation to "catch up" on retirement savings.
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A customized target-date fund risks losing one of its prime advantages -- simplicity.

The problem is that not everyone with the same target retirement date shares the same level of risk tolerance or investment goals. In recognition of this, some companies, including Intel (INTC

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DLX 31.16, -0.50, -1.6%) Corp., have begun offering customized target-date funds in retirement plans that are better suited to their employees' financial situation. Some fund companies, including Old Mutual Asset Management (UK:OML: news, chart, profile) and Wilshire Funds Management, are working to develop multiple flavors of target-date funds -- say, conservative, moderate and aggressive versions for the same target date. And some individuals are using a host of strategies to make these off-the-shelf funds a better fit, while some new products are making it easier for them to build their own customized target-date funds.

Scott Nunn, a 43-year-old in Wilmington, N.C., last year began investing in a target-date fund because he liked that it offered guaranteed diversification and automatic rebalancing of his assets. But instead of choosing a 2030 fund that would closely match his retirement date, Mr. Nunn chose the Vanguard Target Retirement 2050 Fund, which is designed for people who are roughly 45 years from retirement, with an aggressive, stock-heavy investment mix. Mr. Nunn, a writer and graphic designer, says he knows target-date funds aren't designed to be used this way, but he's way behind on his retirement savings, and he's trying to play catch up. "I needed to roll the dice a little bit," Mr. Nunn says.

But customization can have pitfalls, including possible confusion. "All this terminology -- conservative, moderate, aggressive -- none of this means anything to people who are not familiar with investing," says Zvi Bodie, a professor at Boston University School of Management. And "if you are familiar with investing, then you know how mushy those terms are."

Target-date funds have grown swiftly, holding $168 billion at the end of September, up 46% from the end of 2006, according to Financial Research Corp. Although target-date fund assets are dwarfed by the more than $4 trillion in defined-contribution retirement-savings plans, which include 401(k)s, target-date funds are expected to get a big boost from a recent Labor Department ruling that makes it easier for employers to automatically enroll workers in 401(k)s and to offer target-date funds as a default investment. The ruling means that target-date funds will in the future be used by many more workers as the principal savings vehicle for retirement.

Already, some employers are tailoring their offerings to suit their employees' particular situation. The Commonwealth of Massachusetts recently added target-date funds to its deferred-compensation plan that invest more aggressively than many off-the-shelf versions, starting with a 95% stock allocation and devoting 60% to stocks at retirement age. The reason: The plan's participants also have a traditional pension plan that provides steady income in retirement, and so can afford to take more risks in their other retirement savings.

Intel says it adopted customized target-date funds partly because they give the company flexibility to change the mix of investments, or even ditch individual fund managers. "The monitoring of the portfolio in a custom design is a huge benefit," says Stuart Odell, director, retirement investments at Intel. "You have the ability to remove, replace, add additional managers and asset classes as either market conditions change or managers underperform," he says.

Intel recently started automatically enrolling new hires in its 401(k) plan, which has about 52,000 active participants, and participants who don't select their own investments are defaulted into the custom target-date funds.

Deluxe Corp. added custom target-date funds to its retirement plans in August, partly because many off-the-shelf products stopped changing the asset mix once an employee reached retirement age. Nearly a quarter of the Deluxe plan assets are held by people age 60 and over, and "for the demographics of the plan, it didn't seem appropriate to try to make one size fit all," says Mark Kelliher, senior manager of retirement plans at Deluxe.

Old Mutual expects in coming months to launch a lineup of funds with varying levels of risk for each target date. The funds will be available both inside and outside 401(k) plans. And Wilshire is developing funds with nearby target dates in two flavors: one traditional target-date fund and a more aggressive "catch-up" version for investors who haven't saved enough. "I wouldn't be surprised if you start to see funds that have flavors based on high income needs, lower income needs, or funds geared to investors extremely concerned about outliving their retirement assets," says Matt Radgowski, a Wilshire vice president.