Portfolio management is an often neglected task that many people find tedious, mysterious, and a little bit frightening. If this rings true for you or your loved ones, the mutual fund industry has a solution. The last ten years has seen the accelerating growth of a special category of balanced funds with a retirement date in the fund's name, variously called "Lifecycle" or "Target" funds. You simply invest your retirement savings in the fund closest to your desired retirement date, and the fund manager does the rest, providing a suitable asset allocation and adjusting it over time.

At present there are about 120 such funds, about half of which are no-load, with retirement dates extending out to 2055. In light of the Pension Protection Act of 2006, the target-fund solution is destined to expand. Companies are now encouraged to enroll new employees in 401(k) plans as a default, with target retirement funds identified as a suitable investment. The big three -- Fidelity, T. Rowe Price (TRP), and Vanguard -- are the dominate companies in this strategy with over $100 billion in target fund assets.

Retirement Savings on Autopilot

Investing in a target fund is essentially like flying on autopilot. As you travel toward retirement, adjustments to your asset allocation gradually reduce your exposure to stocks and increase your fixed income investments. In fact, this gradual adjustment is often called the glide path, which underscores the flight comparison.

As this chart illustrates, however, there are some fundamental differences in glide paths among the big three target fund companies. While all three allocate nearly 90% of assets to stocks in their 2045 funds, TRP has the shallowest glide path, thereby reducing the stock allocation at the slowest rate. Vanguard's steeper path indicates a more conservative asset allocation as retirement nears. Fidelity's path is the most conservative of all. The glide path is the defining feature of target funds, and we'll take a closer look at the implications of this curve a bit later.

There's a more subtle difference among the three fund families in overall valuation: the ratio of value, core, and growth stocks. Fidelity and TRP remain slightly skewed toward growth across all the target-date funds. Vanguard remains squarely in the middle -- the "core" category.

International Exposure

All three fund families include an international allocation. However, here too there are differences. Fidelity has the highest commitment to foreign stocks, around 25% throughout the target date funds, but then sharply cuts this asset class to about 7.5% after retirement. TRP holds around 23% international during the first fifteen years and then steadily reduces the stake to around 16% in the retirement income fund. Vanguard dedicates about 20% of the target equity portfolio abroad and never deviates, even for the retirement income fund.

The "Fund of Funds" Strategy

Target funds are funds of funds. Fidelity currently offers a dozen Freedom funds constructed as varying mixes drawn from 24 underlying Fidelity funds. Since the component funds are all actively managed (as opposed to being index funds), the net effect is a hierarchy of stock picking, with considerable overlap. For example, the top four funds held in the Freedom 2525 Fund account for 34% of the Freedom 2525 assets. And an analysis of the top 25 holdings in each of these component funds shows that one stock (Johnson & Johnson) is owned by all four, six stocks are owned by three of the four, and 16 stocks are held by two of the four.

The TRP target funds follow a similar model, but with only 13 underlying funds, one of which is an S&P 500 index and the others actively managed. In contrast to the Fidelity offerings, there is minimal overlap among the underlying funds.

Consistent with its reputation for index funds, Vanguard builds its target funds from its index funds: four stock indexes, a bond index, and a money market fund. It also adds a dollop of Inflation-Protected Securities beginning with the 2015 fund and increasing as retirement approaches.

The Lowdown on Expense Ratios

According to the Morningstar Premium Fund Screener the average expense ratio for all funds is 1.37%. By that metric, the target funds we're reviewing here are all relative bargains. The Fidelity fund expense ratios range from 0.51 to 0.79 percent and TRP from 0.56 to 0.76 percent. Because of its underlying index strategy, Vanguard offers significantly lower rates of 0.20 to 0.21 percent.

Performance

12 Month Total Return (November 6, 2007) Fund Fidelity TRP Vanguard Target Income 6.74% 10.37% 9.61% Target 2005 11.38% 10.80% 10.73% Target 2015 12.74% 12.66% 12.11% Target 2025 14.74% 14.04% 13.55% Target 2035 16.47% 14.63% 14.37% Data from Morningstar

A performance comparison across the target fund families can't look back very far because most of the funds are recent additions. While Fidelity launched four decade-spaced target date funds in 1996, they've filled in the gaps and extended the range much more recently. TRP and Vanguard are relative late comers. However, the latest 12-month total returns (during which the S&P 500 returned 9.35%) shows performance consistent with the fund family strategies and current asset allocation mix. Fidelity's lower numbers reflect the lower ratio of stocks to fixed investments. TRP's higher return reflects both its higher ratio of stocks to fixed and its skew toward growth. Vanguard's index approach falls between the two.

About that Glide Path

The target funds dated 25 or more years in the future are all nearly 90% allocated to stocks, which is consistent with modern financial planning. However, most advisors recommend a much higher ratio of equities (at least 50%) in retirement than these target funds offer. And studies of safe withdrawal rates during retirement commonly assume a 60:40 ratio of equities to fixed. Typical of the industry, the target funds from Fidelity, TRP, and Vanguard have glide paths that are too steep. Rather than incorporating the advice of mainstream economists and financial advisors, these companies have tailored their products to the risk tolerance of the typical retiree, who is easily frightened by normal market volatility and underestimates the dangers of inflation. No doubt residual anxieties from the 2000-2002 bear market have contributed to the practice of overweighting fixed investments in the retirement years.

Creative Lying

However, there is a way to enjoy the attractive simplicity of target funds and also have an allocation mix that follows mainstream recommendations: Lie about your retirement date. Simply pick a target date that's 5 or 10 years later than you really plan to retire. At retirement you can still follow a one-fund strategy by switching to a balanced fund with a 60% - 40% ratio. Examples would include Fidelity Balanced (FBALX) and Vanguard Balanced Index (VBINX).

In choosing among the three fund families discussed here, there are some clear grounds for selection. If you favor an index approach or seek the lowest expense ratios, then the Vanguard is the obvious choice. If you're comfortable with a little more risk and want a bit more aggressive asset allocation, then T. Rowe Price is probably a better fit. Fidelity has the distinction of the largest international asset allocation across the target date funds, which may appeal to those who want their portfolio to reflect the growing influence of world markets.

Target funds are usually held in tax deferred accounts -- IRAs and company plans. For the former, you have the ultimate flexibility in fund selection. However, if you have a company plan that offers target funds other than the ones discussed here, you can make your own analysis of asset allocation, expense ratios, and glide path to help guide your decision.

If you're a self-confident, individualist investor who enjoys picking funds and competing with the market, then target funds won't hold much appeal. However, if you're looking for a hands-off approach to asset allocation and rebalancing and want to avoid paying a financial advisor to do it for you, then a target fund, with some "creative lying" about your retirement date, might be just the ticket.

A condensed version of this article appeared in the May 2007 Motley Fool Rule Your Retirement newsletter.