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By Christine Benz | 09-27-2010 05:53 PM

Customizing a Target-Date Fund

Vanguard's John Ameriks says most investors should consider their financial situation holistically and tweak a core target date fund with satellite holdings.

Christine Benz: Hi, I'm Christine Benz for Morningstar.com.

Do target-date investors behave any differently from other types of retirement plan investors?

Here to discuss that question is John Ameriks. He is Head of Investment Counseling and Research at Vanguard. John, thanks for being here, today.

John Ameriks: Glad to be here, Christine. Thank you.

Benz: So, one question, I'd like you to address for us, John, is, because participants in target-date plans don't see all these individual investments moving around every day or every quarter, do they tend to behave a little more rationally when managing their assets than people who are trying to control a lot of different investments?

Ameriks: Well, I'm with the rest of the world in not knowing to what degree people are rational or irrational. What I can tell you is that the work that we have done looking at behavior suggests that folks who own target-date funds were a little less likely to engage in transactional activity over the rough patch that we had in the market over the last couple of years.

Now, we don't know whether that's something special to target-date funds or something about balanced fund investors. Basically, they understand, they've got a strategic asset allocation, and they need to stick with it over the long term to let it work. So, I unfortunately can't answer the big question.

Is that a rational choice or is that irrational inertia? It's really difficult to tell that. But we do know that the net result so far has been behavior that we think is consistent with getting to the right place over the long term. So, it's good news on that end.

Benz: Okay. So, in terms of how people put together portfolios that include a target-date fund. You sometimes hear these horror stories about someone picking 2020 and 2030. What do you see in terms of how people put together portfolios that include target-date?

Ameriks: Right. These are the stories of the target-date fund abusers that we hear about.

There are a lot of different patterns in terms of how people use target-date funds, so a couple of things from the work that we've done on this. One is that, in many cases mix portfolios, a target-date fund with something else, doesn't reflect an active choice that was made by an individual, but it may reflect something that a sponsor has done in the context of a plan. And that could be having a match that's in company stock or having closed a fund option and re-enroll people in that fund into a target-date fund and leaving them with that exposure.

So, in a lot of cases, it's not individuals making those changes; it's employers. And employers offer company stock for what they believe to be very good reasons. So, including it as part of a portfolio, we think, can make sense.

We also think that even those individuals who do take steps to hold something other than a target-date fund can do that in a way that's consistent with making best use of their 401(k) plan. We offer 401(k) plans to people to allow them to exercise choice around what types of investments they want to make.

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