Target-date funds have been a boon to the investment industry, helping to get people to save for retirement, but some big changes could be coming soon aimed at making sure nest eggs are better protected.
Introduced in the early 1990s, the majority of defined contribution plans now default into a target-date or other professionally managed account. The asset allocation in such funds becomes more conservative as the target date (usually retirement) approaches.
See also: Beware of target-date funds
TDFs were created because “Americans are terrible at investing,” said Ric Edelman, CEO of Edelman Financial Services in Fairfax, Va., and author of numerous books on investing. “They either take too much risk or too little risk and they enter and leave the stock market at the wrong time.”
He believes that the premise behind TDFs remains a good one: Get people to save who wouldn’t normally save and place them in a managed, diversified portfolio that becomes less risky as they age.
“Given the choice of letting the worker fend for himself and figure out what to invest in and when vs. using professional management offered by the fund, for most workers, they are better off in a TDF,” he said.
But problems have arisen.
In 2008, when the market took its latest nose-dive, many Americans lost up to 40 percent or more of their retirement accounts because they were invested in target-date funds. The losses cast a light on the many ways target-date funds are set up and sparked much debate among industry participants, the Department of Labor and the Securities and Exchange Commission.
Many of those who suffered losses in the ’08 meltdown were invested in 2010 target-date funds, so their investment in equities should have been lower and their investment in bonds higher since they were so close to retirement. That was not the case.
Some TDFs have a “to” glide path, meaning the assets in these accounts will be invested more conservatively every year as the owners get closer to their retirement year.
Alternatively, TDFs with a “through” glide path also get more conservative over time, but their managers try to balance the portfolio based on the assumption people will live to be age 90 and that they will still need to be earning money on their investments until they reach that age.
Edelman believes there are two things that can be done to improve the TDF market: tighten rules limiting their diversity, so there isn’t that much difference between one fund and another and, not surprisingly, get workers better educated about how these funds work and how to take advantage of them.
In April, the SEC’s Investor Advisory Committee agreed that most individual investors are ill-equipped to identify the risk disparities among similar-seeming funds. It also found that many professional pension fund consultants underestimate the degree of risk in many target-date funds.
To underscore the disparity point, a recent Morningstar study of 36 funds with a target date of 2020 found that their equity weightings ranged from 35 to 80 percent.
So the committee urged its overseers at the SEC to develop an alternative glide path illustration based on the target risk level over the life of the fund.
Related story: EBRI: Nearly three quarters of 401(k) plans include target date funds