Target-date funds were supposed to be the ultimate idiot-proof investment vehicle for retirement savings.

The idea is that asset allocation is the single most important factor in determining investing success, and most people get it wrong. Many others never even try because they find the concept too daunting.

Many people know they should save for retirement, but they don’t want to be investors – they don’t know whether they should invest in stocks, bonds, or mutual funds. Enter target-date funds.

Target-date funds are supposed to take all that complexity out of saving for retirement. You simply choose the target date of your retirement, and the investment firm does the rest. It’s like auto pilot, with the fund manager gradually shifting more of your assets to bonds as your retirement date gets nearer, thus reducing the volatility and preserving the value…. in theory.

What happens when theory meets reality is a different story.

As a recent article from USNews points out:

“Many target-date fund investors, including those near retirement age, recently suffered large losses. Long-term investors with a retirement date between 2050 and 2055 had a median return of negative 47.5 percent between October 2007 and February 2009, according to a recent Watson Wyatt analysis of 72 target-date funds.”

No big deal, right? I mean 2050 is a long way off, and those investors should expect some volatility in order to earn more overall. Fine. But here’s where it breaks down:

“Those on the verge of retirement didn’t fare that much better. Investors interested in retiring in 2010 had a median return of negative 31.9 percent. But losses varied considerably among funds because of the large differences in stock market exposure. Funds with a target date between 2050 and 2055 were invested between 51 percent to 95 percent in equities, Watson Wyatt found. Those with a retirement date of 2010 had between 32 and 80 percent of the fund exposed to the stock market.”

Two years out from retirement and some funds had as much as 80% in stocks?!

That’s criminal!

Those managers got greedy and wanted to keep their returns high, so they took on much more risk than advertised. That violates the entire intent of target-date funds, and also violates the faith with which investors invested in those funds.

Let this be a stark reminder that there is no true risk-free, cruise control method for investing. You have to know what you’re investing in.

Incidentally, this is also a reminder of why index investing is so popular. People in those funds could have invested 80% of their money in a broad based ETF (like the Vanguard Total Stock Market ETF VTI) and 20% in the iShares Lehman Aggregate Bond AGG ETF and gotten the same results (OK, very similar results) with far less fees and the knowledge that such losses were an inherent risk of the asset allocation, and not subject to the whim of a fund manager!

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Here’s the ultimate in super-simple investment portfolios, for those who don’t have the time or inclination to pick and monitor individual stocks.

The One-Minute Portfolio.

The One-Minute Portfolio is comprised of just 3 asset allocations: Domestic Stocks, Foreign Stocks and Bonds. Here’s a recommendation for each category:

1. Buy America – The Whole Darn Thing!

Perhaps the cheapest and easiest way to own the entire U.S. Stock market is through the Vanguard Total Stock Market (VTSMX) mutual fund, or Vanguard Total Stock Market ETF (VTI). Both capture all market caps from small to large, growth to value and all sectors – and they have a low expense ratio: 0.16% and 0.07% respectively.

2. Going Abroad.

Here is a mutual fund and an ETF that will let you own the rest of the world, from emerging markets to the more mature European markets. Vanguard Total International Stock Market (VGTSX) Fund or Vanguard FTSE All-World ex-US ETF (VEU). Expense ratios are 0.30% and 0.20% respectively.

3. Bonds.

Bonds often give ballast to your portfolio during time when stocks are tanking, with the rare exceptions (think 2008). The biggest problem most investors have when buying bonds is deciding on what maturity to buy – short, intermediate or long term? You don’t have to pick just one. Here’s a super simple way to own the bond market – all of it!

Vanguard Total Bond Market (VBMFX) fund, iShares Lehman Aggregate Bond
(AGG) ETF. There is the Vanguard Total Bond Market ETF (BND http://quote.morningstar.com/ETFQuote.html?ticker=BND), but it’s less than a year old. The expense ratios are: 0.20%, 0.20%, and 0.10% respectively.

As with any portfolio, you’ll have to decide what percentage each category should be in your portfolio, based on your target time and risk tolerance.

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Looking for an easy, diversified portfolio of stock funds that will grow your money over time, but won’t take over your life with demands on your time? ladies, gentlemen and undeclared’s, I present the simple 7 portfolio..

Each recommendation is either an ETF, or a no-load mutual fund. Some people prefer mutual funds, and others ETFs, but there is little difference here. Most are also index tracking funds, so they are relatively low maintenance – for the set it and forget it, long term buy and hold investor. Most expense ratios are under 1%

The Simple 7 Portfolio.

1. A blue-chip U.S.-stock fund.

• iShares S&P 500 Index (IVV )

• Selected American Shares (SLASX)

• Fidelity Spartan 500 Index (FSMKX)

2. A blue-chip foreign-stock fund.

• Vanguard Total International Stock Index (VGTSX )

• Vanguard FTSE All World Ex-U.S. ETF (VEU)

• Dodge & Cox Intl. Stock (DODFX ) .

3. A small-company fund.

• Vanguard Small-Cap ETF (VB ).

• T. Rowe Price New Horizons (PRNHX)

• Vanguard Small-Cap Index (NAESX)

4. A value fund.

• iShares S&P 500 Value Index (IVE)

• Vanguard Value Index (VIVAX)

• T. Rowe Price Equity Income (PRFDX)

5. A high-quality bond fund.

• Vanguard Total Bond Market ETF (BND)

• Vanguard Total Bond Market Index (VBMFX)

• Harbor Bond (HABDX)

6. An inflation-protected bond fund.

• Vanguard Inflation-Protected Securities Fund (VIPSX)

• T. Rowe Price Infl.-Protected Bond (PRIPX)

• iShares Lehman TIPS Bond (TIP)

7. A money-market fund.

• Fidelity Cash Reserves (FDRXX)

• Vanguard Prime Money Market (VMMXX)

• Schwab Value Advantage Money (SWVXX)

I leave the actual asset allocation to you, since that will depend on your time horizon, risk tolerance and so forth.

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