The good and the bad about target-date funds

As dark as this recession has been, it's had an upside in that it has exposed myriad problems in the investing industry.

 

Take, for example, "target date" investment funds, which were created to help investors achieve the right mix of asset classes.

 

I'm a fan of the funds because they allocate your money among various asset classes and automatically shift from riskier investments to more conservative ones as you reach a certain "target" period, such as retirement.

 

At the end of 2008, $109 billion invested in target date mutual funds was held in defined contribution plans, such as 401(k) plans, according to the Investment Company Institute.

 

Think of target date funds, which are also called lifecycle funds, as operating like the "set it and forget it" machines that allow you to roast chicken with little effort.

 

The idea is that you don't have to closely monitor your investment account because the asset allocation and rebalancing is done for you. It's why the Department of Labor endorsed the funds, allowing them to be one of the default selections in 401(k) plans.

 

However, the recession and the resulting downturn in the stock market have illuminated a problem with target date funds, including how people perceive them.

The U.S. Senate Special Committee on Aging held a hearing earlier this year in part to discuss target date funds within 401(k) plans.

 

A committee investigation of funds designed for people planning to retire in 2010 found a broad variety of stock exposure -- and losses -- although the funds had the same target date.

 

It's this wide berth that worries the Department of Labor's Employee Benefits Security Administration and the Securities and Exchange Commission. The two agencies held a hearing last month to discuss concerns about how target funds are managed and marketed.

 

"We have serious concerns that these funds are fundamentally misleading to investors because they are allowed to be managed in ways that are inconsistent with reasonable expectations that are created by the titles in the use of the names," testified Marilyn Capelli Dimitroff, chair of the Certified Financial Planner Board of Standards.

 

The average loss in 2008 among 31 funds with a 2010 target date was almost 25 percent.

 

Returns of 2010 target date funds in 2008 ranged from minus 3.6 percent to minus 41 percent, SEC Chairman Mary L. Schapiro said during the hearing.

 

"These varying results should cause all of us to pause and consider whether regulatory changes, industry reforms or other revisions are needed with respect to target date funds," Schapiro said.

 

"Of all of the issues that the SEC is examining at the moment, our review of target date funds is one that may most directly affect everyday Americans seeking to access our securities markets to help build a better life, and a greater sense of financial security, for themselves and their families."

 

No question federal regulatory agencies owe us an examination of target date funds. Have the hearings.

 

But please, oh please, if regulation is necessary, make sure it really benefits the average investor.

 

One thing officials can do is make sure investment companies are thoroughly explaining the nuances of target date funds.

 

Karrie McMillan, general counsel for the Investment Company Institute, says there are five key pieces of information you ought to know about a target date fund:

 

What's the relevance of the date used in a fund name, and what happens on the target date?

 

Will your money be shifted to more conservative investments as the target date approaches, or is the fund designed for an investor who plans to withdraw money gradually after the target date has been reached?

 

What is the age group for whom the fund is designed?

 

At what point does the fund reach its most conservative asset allocation?

 

Some providers design their funds to reach the most conservative asset mix at or shortly after the target date.

 

These funds place a higher priority on producing immediate income and preserving assets at retirement age, McMillan said.

 

Other target date funds may be designed so that the fund reaches its most conservative asset allocation 10 or 20 years after the target date.

 

Is there sufficient disclosure to investors that investing in a target date fund does not guarantee a certain return?

 

"Because this downturn has hit a wide range of asset classes, diversified investments such as target date funds have not been immune," McMillan said.

 

I'm still pulling for target date funds, especially as part of workplace retirement plans.

 

"Target date fund investors avoid extreme asset allocations that we often observe in retirement accounts -- the 25-year-old holding all cash, or the 60-year-old fully invested in equity funds," McMillan said.

 

Having a "set it and forget it" investment option is vital for people concerned that they won't get the asset mix right as they near retirement.

 

Contact Michelle Singletary c/o The Washington Post, 1150 15th St. N.W., Washington, D.C. 20071, or e-mail singletarym@washpost.com.

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