TAKING STOCK

2020 Foresight

by Malcolm Berko

Dear Mr. Berko:
My wife and I are 57 and have been in business together for 21 years. We expect to retire in 10 to 11 years. We are in real estate sales and do not have the benefit of a pension or retirement plan so we are basically self-employed. We do have Simplified Employee Plan-Individual Retirement Accounts, each of which is worth about $166,000. In the past two to three years, we have not done very well and we are getting worried about retirement. Our accountant suggested that we each put our money in a target fund. He didn't recommend a specific fund but said to write you and that you would recommend a target fund for us.
N.W.
Louisville, Ky.

Dear N.W.:
 So far no one has developed an intelligence test to equal matrimony and I am really impressed that you two are still married after 21 years of working together. I think your CPA's recommendation of a target fund makes good sense for you. I like them for some folks because they simplify the concept of long-term investing.

Basically, you select the year you intend to retire and then chose the target fund closest to that date. And because you guys are 57 and wish to retire in 11 years, the closest target fund for your goal is the year 2020. These funds are a balance of various investments: small-cap issues, emerging growth stock, foreign stocks, large-cap issues, master limited partnerships, real estate investment trusts, blue chips, technology stocks, convertibles, corporate bonds, value stocks, etc. As the fund approaches its target date, the portfolio becomes more conservative and the percentage of bonds, preferred issues and cash increases while the percentage of equity investments decreases. This "glide path" reduces the funds volatility as well as the possibility of big losses as your retirement nears.

Most advisers recommend a single target fund. However, I prefer to cover more bases so I will recommend three target 2020 funds: Fidelity Freedom 2020 (FFDX), T. Rowe Price Retirement 2020 (TRRBX) and Vanguard Target Retirement 2020 (VTWNX).

While they all have the same target dates they have different portfolio structures and their glide paths function a bit differently.

FFDX's portfolio is very broadly diversified, using a combination of 25 different underlying Fidelity funds. It uses a moderate glide path that becomes increasingly conservative, reducing its equity exposure from 70 percent to 50 percent over the next 12 (2020) years. Then during the next 15 years after the Target date it will have about 20 percent of its portfolio in Fidelity's domestic equity funds, 25 percent in Fidelity's investment grade fixed-income funds, 5 percent in Fidelity's high-yield fixed income funds and 40 percent in Fidelity short-term funds. The expense ratio is 0.76 percent and the five-year average return is 10.9 percent.

TRRBX invests in underlying T. Rowe Price mutual funds and is best for those who prefer a higher allocation of stocks at the target date. About 80 percent of the portfolio is invested in various T. Rowe Price sector funds while 20 percent of the portfolio is in T.

Rowe Price fixed-income funds. TRRBX has an aggressive glide path because as it reaches its target date the portfolio will still have 60 percent of its assets in equities. So after the 2020 target date, the glide path reduces its equity exposure quite slowly during the next 20 years to a final allocation of 20 percent. The expense ratio is 0.69 percent and the five-year average return is 12.5 percent.

VTWNX may be the most conservative of these three target funds and it certainly has the lowest expense ratio. Vanguard uses seven of its underlying index funds, which means that they track an index rather than requiring a portfolio manager to choose individual issues. In a down market, index funds are often less volatile than a portfolio of individual stocks. The typical portfolio is 72 percent equities and 28 percent bonds. In the years leading up to the 2020 target date, the moderated glide path reduces its equity exposure to 50 percent. Then during the following seven years the equity exposure reduces rapidly to a final 30 percent. The expense ratio is 0.20 percent and it does not have a five-year record.

These funds can be bought for your 401(k) plans, IRAs, Roth IRAs, SEP IRAs and profit-sharing plans but so far they're not available for 403(b) plans so if you're a teacher, hospital employee, etc., then you're out of luck.

Most large mutual fund families offer target funds with glide paths reaching out to 2045, which is convenient for young folks who are more interested in their hobbies and families than retirement investing. Templeton has a good choice of target funds and so does Schwab, Barclays, American Funds, Scudder, Merrill Lynch, MFS, Allianz and Wells Fargo, to name a few.

Please address your financial questions to Malcolm Berko, P.O. Box 1416, Boca Raton, FL 33429 or e-mail him at malber@comcast.net.
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