Take control of your target date fund

You may have thought that after you put your money into a target-date fund, it would stay there until you retire. But taking such an approach could be a bad idea. The reason: Fund managers tinker with their funds. Companies such as Fidelity, Vanguard, and T. Rowe Price sometimes adjust the retirement formula they use to optimize the returns of those funds.

Though that may turn out to be good news for your retirement savings, it could also mean that you end up taking on more risk than you had initially expected. That's because the target-date fund may have become more aggressive (or in some cases, more conservative) than when you originally invested.

That change happens when managers alter the "glide path" of the fund (the proportion of your money invested in stocks, bonds, and other assets that changes as you age). It can happen without you even realizing it. Usually target-date funds shift from an almost all-stock allocation when you are younger toward investments that are more income-oriented as you approach retirement. The idea is to give your savings every opportunity to grow in the early part of your working career, when there's time to recover from any short-term mishaps in the stock market, and to preserve your savings at the cusp of retirement by investing in less risky assets such as bonds.

Since 2009, most glide paths have been recalibrated, particularly the funds of those closest to retirement age (those labeled 2015, 2020, and now 2025). As a result, the differences in the asset allocations are less drastic now than they were in 2009.

Back then, for example, a target-date fund designed for someone retiring in 10 years could have had an exposure to stocks as high as 81 percent or as low as 37 percent. Today that exposure has narrowed from a high of 75 percent (American Funds 2025 Target Date Retirement fund) to about 50 percent (the John Hancock Retirement Choices at 2025 fund).

Some funds have been making adjustments more than others. T. Rowe Price, one of the largest target-date fund providers, has altered the glide path for its target-date funds the least over the years, according to Ibbotson Associates, a division of fund industry monitor Morningstar. Fidelity, another of the big three target-date families, has made the most adjustments. (Vanguard, the third target-date giant, is somewhere in between.)

Passive aggressive

Stocks have gone nowhere but up over the last three years, so it's no surprise that the target-date funds with the most aggressive glide paths performed better over that time period. In down markets, the conservative funds will lead.

Figuring out the right asset allocation has long involved some trial and error. In their formative years, target-date funds grew in importance after congressional legislation in 2006 mandated that employers' 401(k) plans offer an appropriate default option to workers. Some pre­retirement portfolios proved to be far too aggressive at the most inopportune time, exposing preretirees to a high percentage of stocks. That happened during the market crash of 2008 to 2009, which torpedoed the retirement savings of many investors.

Alas, choosing the target-date fund family that has the "best" asset allocation isn't in your control. Your employer, as the retirement plan sponsor, chooses the target-date fund family, one you're probably stuck with unless the employer shops for a new plan.

But there are steps you can take to make investing in target-date funds optimal for you:

• Look at all of the target-date funds your retirement plan offers. If your plan offers target-date funds that invest more in equities than you are comfortable with in the years leading up to your retirement, consider choosing a fund with a retirement date five or 10 years before you actually plan to retire. That way, the shift from equities to bonds will happen sooner.

• Consider the fees for the actively managed funds that are included in your target-date fund. Some are packed with expensive, underperforming, actively managed funds that can be a drag on your returns. But there has been some improvement when it comes to fees. Taken as a whole, the average target-date fund expense ratio was 0.91 percent in 2013 according to Morningstar, significantly lower than in 2008, when the expense ratio was 1.04 percent.

If you're lucky, your employer hasn't chosen one of the target-date fund families with higher-than-average expense ratios. Among the 10 largest target-date providers, the American Century One Choice 2025 is the most expensive "R" class fund, with a current net expense ratio costing investors 1.35 percent annually (its institutional "I" class shares are cheaper). Fidelity Freedom (one of two classes of target-date funds that Fidelity offers) and TIAA-CREF are the least expensive active funds, costing investors just 0.16 percent annually.

• Fashion your own target-date fund if your plan offers only expensive options. You can do that by using lower-cost equity and bond funds, if they are offered by your 401(k) plan. Remember, cost is important, but you can't overdo it. If you choose to place your money in a money market account to avoid the fees, it will also have no hope of growing.

• Don't ‘split the difference' with target-date funds. Putting half of your money in two or more target-date funds, or even half in a target-date fund and half in other investments within the plan, is counterproductive. By investing outside of the target-date fund, you're undermining the allocation that has been carefully designed for investors with your investment horizon.

Still not sure which target-date fund is right for you? It's not perfect, but selecting a fund based solely on your anticipated retirement age is likely to be appropriate for your financial situ­ation, and it may be similar to an allocation that a dedicated financial adviser would draw up for you. In that sense, target-date funds are doing exactly what Congress intended them to do eight years ago: ensure that retirement-plan participants choose an appropriate investment.

Finding the right path

Five years ago the asset allocations of the largest target-date funds varied considerably. Today, although the average asset allocation is almost identical to that in 2009, the most aggressive and conservative funds hew closer to the average.