Target-date funds (TDFs), especially those with a 2010 date, have received a lot of scrutiny. As has been widely reported, many funds in this category suffered significant losses during the bear market, and the drop in portfolio values reportedly has forced some near- or recent-retirees to reconsider and adjust their plans. The funds have drawn regulators’ attention, as well: the SEC and Department of Labor recently held a joint hearing that examined numerous aspects of the funds’ operations.
The current climate for TDFs stands represents a dramatic change in attitude. Lyman Jackson, CFP with Jackson Financial Advisors in Newton, Mass. (with securities traded by Royal Alliance), recalls that when the concept of target date funds first came out, it attracted a lot of excitement as an innovative product.
“Many argued that it was really taking the retirement plan of the 401(k) or the 403(b) marketplace to the next level by making it easier for the everyday person who has a plan to make some kind of decent choices for a comfortable retirement,” says Lyman. “It simplifies the process dramatically. Theoretically, all that one needs to do is to determine the year that they plan to retire and pick a target date fund that has a target year that is close to that year.”
Much of the recent bad press has focused on the wide variation in equity allocations (and resulting volatility) among TDFs with the same target date. Those criticisms ignore several important points, however.
Traditional TDFs do not convert into risk-free accounts when they reach the target date; instead, they hold allocations that consider the investors’ life span, which is often 20 years or longer.
The second issue is that TDFs are designed for long-term asset allocations that change slowly over time — they’re not set up for market-timing.
“Unless someone had a prescient view of what was coming, even a large, carefully managed, advisor-controlled account didn’t do what it was ‘supposed’ to do in this kind of volatility,” says Ellen Siegel, CFP, ChFC, CLU with Ellen R. Siegel & Associates (trading via LPL Financial) in Miami. “So when I read about planners or researchers attacking target date funds as having not done what they are supposed to do, I think that’s not fair.”
TDFs held an estimated $164 billion at year-end 2008, of which roughly two-thirds was in 401(k) accounts and defined contribution plans. The factors that made them popular still hold, and Barry Korb, CFP with Lighthouse Financial Planning LLC, which trades through TD Ameritrade and is based in Potomac, Md., notes several cases when he would consider recommending a TDF:
- For a beginning investor who does not have enough (e.g., in their retirement plan) to meet multiple individual fund minimums. In this situation target date funds offer a low cost way to achieve some degree of diversification.
- For a retirement plan employer to place its safe harbor contributions given current regulations.
- As an interim vehicle for a client’s funds while he developed an appropriate allocation rather than leave them in what would otherwise be a totally unacceptable portfolio.
- As a vehicle to achieve some automatic, rebalancing in situations where needed rebalancing would not likely otherwise occur.
Siegel believes that TDFs can benefit smaller investors because the funds offer automatic investing, low costs, professional management and immediate diversification.
When researching the target date funds that are available to her clients, she uses Morningstar’s reports, the fund’s website, and proprietary research available through LPL, her broker-dealer. After examining the funds, she may suggest that the client choose a fund with a different date than the client’s planned retirement date if the other fund provides a more appropriate allocation. Korb has taken a similar approach with clients.
One positive outcome from TDFs’ recent problems is that investors will pay closer attention to the asset mix and potential volatility in their retirement plans. That increased understanding doesn’t mean the plans will become less popular, though, because the factors that helped spur the plans’ growth are still in place.
“(TDFs) work very well for people who don’t have either the time or the talent or the inclination to spend a lot of effort on managing their own investments,” says Jackson.