The all-in-one fund fix
Mutual funds with built-in diversification can be a great tool--if you use them correctly.
By Janice Revell

(FORTUNE Magazine) – THEY'RE TWO OF THE DEADLIEST SINS THE average investor can commit: failing to diversify a portfolio properly and neglecting to rebalance. Because avoiding them requires regular vigilance, they are also among the most common. So it's not all that surprising that a new breed of all-in-one mutual funds promising automatic diversification is now exploding in popularity. Investors have plowed some $36 billion into these one-stop-shopping funds over the past three years. They're a great idea for many investors. But to get the most bang for your buck, you need to do some homework. Follow these three simple rules before investing in an all-in-one fund:

●Learn the jargon. There are two major types of all-in-one mutual funds--"lifestyle" and "target maturity" funds. They both offer diversification in a single investment, but they're very different creatures. The lifestyle version maintains a static mix of stocks, bonds, and cash; these funds typically carry names like "moderate" or "conservative" allocation, depending on the weighting given to stocks. But the onus is on the investor to switch to the fund that's most appropriate as he ages and his risk profile changes.

By contrast, target maturity funds are truly no-maintenance. You make your choice based on the expected year of your retirement--for instance, if you were buying a fund today and planning to retire in 20 years, you might pick Vanguard's Target Retirement 2025 fund. Like all major target maturity products, it's actually a fund of funds. Most of its money is invested in four underlying mutual funds--the Total Stock Market Index, the Total Bond Market Index, and European Stock and Pacific Stock index funds. Once you've invested, the company automatically adjusts the mix of stocks and bonds to more conservative levels as time passes. So if your primary goal is to put your retirement savings plan on autopilot, the target maturity funds are the best choice.

●Read the fine print. You still need to do a bit more research before diving into a specific target maturity fund. That's because funds that are targeted to the same retirement date can vary considerably in their asset allocation strategies. For instance, the current allocation of the Fidelity Freedom 2025 fund is about 75% in equities. Vanguard's Target Retirement 2025, on the other hand, holds a more conservative equity allocation of about 60%.

●Surrender to the "hands off" formula. By their very nature, target maturity funds are designed to be all-in-one portfolios, with the asset allocation specifically calibrated to yield the right amount of risk. But if you buy a pile of other funds in addition to these all-in-one products, you'll be throwing that carefully determined asset allocation right out the window. Yes, the thought of sinking most of your money into one mutual fund can be pretty scary. But remember, these are actually multiple funds wrapped in one easy-to-manage package. So this is one case where it really does make sense to put all your eggs into one basket. ■