The Do-It-Yourself Retirement Fund

Target-date funds are supposed to make saving for retirement easier by offering a one-shot, premixed portfolio that grows conservative as the years pass. All investors need to do is select an anticipated retirement date and voilà! Investment professionals handle the legwork, which includes allocating money to stocks and bonds and adjusting the portfolio to lean more heavily toward bonds as the target date nears.

Now, some firms are offering customizable target-date funds for investors who feel boxed in by the one-size-fits-all approach. Foliofn, a Vienna, Va., brokerage, recently launched a series of "building block portfolios," which come in moderate, conservative, and aggressive variations for each target date offered. (A "Folio Wizard" helps investors choose the best fit.)

Each "folio" contains a basket of exchange-traded funds (ETFs) that gradually shifts to a more conservative allocation over time. Here's the twist: Investors can tweak their portfolio at will, since they technically own the ETFs directly (unlike mutual funds, the folios aren't run by a paid fund manager and registered with the Securities and Exchange Commission). For example, investors who are already heavily exposed to a particular sector through company stock can tune up their allocations to other industries or asset classes, says Geoff Considine, a strategic adviser to Foliofn.

That's how it's supposed to work. Foliofn insists that the structure promotes flexibility, not market timing. "There is a difference between customizing and trading in and out of positions," says Steve Wallman, Foliofn's chief executive officer and founder.

Still, emotions tend to play an influential — and often hazardous — role in investing. Morningstar's research on the gulf between funds' reported gains and what investors actually earn shows that investors tend to pile into funds at the tail end of a hot streak and sell after performance has gone cold.

"If you're handed a basket of securities which together create a diversified portfolio, tinkering with it could defeat the whole purpose," says Tim Courtney, chief investment officer of Oklahoma City-based Burns Advisory Group. However, Courtney says customization is a step in the right direction: "The main drawback of target-date funds is that you lose some degree of control of the portfolio, so being able to specify your own characteristics is a good thing. You can't assume that when you turn 60 or 65 that you'll want to invest like every other 60- or 65-year old."

Customization is catching on. Eaton Vance, a load family of mutual funds (investors pay upfront commissions), also offers target-date funds that put you in the driver's seat. Investors choose from a pool of Eaton Vance tax-managed stock and municipal bond funds, select a target date, and specify a starting and ending allocation.

Another load manager, Old Mutual Asset Management, launched a handful of funds earlier this month that use 10-year ranges instead of one target year. For each range, Old Mutual provides a conservative, moderate, and aggressive portfolio.

Foliofn charges a monthly fee of $29, which includes unlimited brokerage trades. That adds up to nearly $350 per year, plus investors pay the underlying expenses on each ETF in the portfolio. The firm's Target 2040 "moderate" folio, for example, includes 11 ETFs with a combined expense ratio of 0.43 percent. According to Morningstar, the average expense ratio for target-date funds (quoted in the prospectus) is 1.25 percent.

Target-date funds have grown at a rapid clip since their debut about a decade ago. The funds held $184.2 billion in assets at the end of February, a 43 percent jump from a year earlier, according to Morningstar. With nearly 80 million baby boomers set to retire over the next two decades, it's no surprise that companies are rolling out more and more twists on the target-date concept.

Even providers of exchange-traded funds are getting in on the game: In late 2007, XShares Advisors and TD Ameritrade launched the TDAX Independence funds, the first target-date ETFs. State Street Global Advisors has plans in the works for its own version.

Since managers have different ideas about the best mix of assets, target-date funds can vary widely. Holdings range from plain-vanilla stock and bond mixes to those that incorporate more exotic fare, like commodities or real estate investment trusts (REITs). Compare, for example, the same target retirement date from two fund families: Vanguard Target Retirement 2040 and Fidelity Freedom 2040. Vanguard's fund currently holds about 90 percent of its assets in stocks, and nearly three-quarters are large-company stocks. The Fidelity fund throws more small and midsized companies into the mix, but its stock allocation is considerably lighter, at 68 percent of assets.

Foliofn's Target 2040 "moderate" folio is a different animal entirely. Its 11 ETF holdings include a pair that invest in Japan and Malaysia, respectively; a fund that follows the small-company-focused Russell 2000; and funds that individually track transportation, utilities, telecommunications, and REIT indexes. The idea is to maximize diversification, Considine says. "It's striking how many of the existing target-date solutions simply track the S&P 500," he says. "Some ignore whole asset classes, like commodities. The premise of [the Foliofn funds] is to diversify the way pension plans diversify."

Of course, investors who'd rather take a hands-on approach can assemble their own mix of mutual funds or ETFs and adjust the allocation each year. That would be total control.