Why Target Date Funds Face Heat - and Probable Reforms
Mark Miller - Retire Smart
Make Sure Financial Arrangements Are in Order (Mark Weber)
Target date funds need to sharpen up their aim.
These funds, which offer a way to put your 401(k) investing on cruise control, are taking a lot of heat due to the large losses suffered by some close-to-retirement investors in the market crash. At a
Target funds are good at addressing a basic problem with 401(k) investing--namely, that many people just don't want to, or can't, manage their own portfolios. That fact is reflected in asset allocations that often are shockingly inappropriate for investors' ages.
Nearly one in four investors approaching retirement age (56-65) had more than 90 percent of their account balances in equities at the end of 2007, and more than two in five had more than 70 percent in stocks, according to the
With a target fund, you simply pick a fund targeted for the year you expect to retire; the fund manager adjusts the asset mix as the target year approaches, reducing the percentage of equities and increasing fixed-income investments to make the overall mix more conservative.
Assets in target date funds have been soaring over the last few years, a trend that stems from the passage of the Pension Protection Act of 2006 (PPA), which included a broad set of needed pension reforms. One of the most significant provisions addressed the issue of investor inertia by clearing the path for plan sponsors to offer automated investment options called target date, or lifecycle retirement funds.
In a broad sense, target date funds offer an opportunity for investors to improve their asset allocations.
But here's the rub: The PPA doesn't set any definitions for appropriate equity exposure levels by age group, so fund managers have been free to manage the investment mix as they see fit. As a result, target date funds have come under fire since the crash because many of the funds tailored for investors near retirement age racked up significant losses.
Clearly, many older investors thought they were buying more protection from market risk than that when they bought target date funds. The problem centers on the so-called "glide path" to retirement--the approach taken by fund managers to reducing your exposure to equities or other risky investments as you get older. Approaches here vary, but most of the big mutual fund management companies argue that investors need to maintain a healthy amount of equity exposure to help insure against the risk that they'll outlive their money.
These glide paths are based on analysis of long-term market performance showing that equities outpace other investment options, but they seem too aggressive for people within 10 years of retirement age, considering the highly uncertain outlook for markets and the economy in the years ahead.
At a joint hearing held in June by the
Regulation of asset mix is under discussion, but seems far less likely to occur. So if you do use a target date fund, be sure to understand its glide path, and decide if you're comfortable with the equity exposure. If not, you can fashion a more conservative investment mix and make plans to insure for longevity risk via another route--for example, an income annuity or deferred longevity policy.
Investing - Why Target Date Funds Face Heat - and Probable Reforms
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