Your 401(k): Target Date Funds Disappoint

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By one estimate, target date funds are becoming the $2 trillion leader in the retirement savings world.

But there's much discontent over the early track record of these funds that are supposed to provide an easy and secure way for today's workers to manage their own retirement portfolios.

If you put money in a target date fund, your investments are rebalanced automatically to a more conservative mix as your retirement year approaches. Hence, 2045 funds appropriate for today's 30-year-olds should be invested much more aggressively than a 2010 fund aimed at someone looking to retire this year.

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The popularity of target date funds has soared since a 2007 federal regulation allowed them to serve as default investment choices for employer-sponsored retirement plans that automatically enroll newly hired workers.

BrightScope Inc., which rates company 401(k) plans, projects that by the year 2020, target date funds will hold more than $2 trillion and represent a third of all 401(k) assets.

The current discontent over target date funds stems from their dismal performance during the 2008 market meltdown -- particularly for investors closing in on retirement, who saw their nest eggs drop by 25 percent or more.

Among 31 funds targeted at a 2010 retirement, the average loss in 2008 amounted to nearly 25 percent, according to figures cited by Securities and Exchange Commissioner Chairman Mary L. Schapiro. The 2008 losses for these 2010 target date funds ranged from a low of 3.6 percent to a high of 41 percent.

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As a result, target date funds have come under scrutiny from Congress, the Securities and Exchange Commission and the Department of Labor.

Earlier this month, Schapiro announced she would be proposing this year new disclosure and marketing rules for target date funds. She said the SEC will "confront the issue of the potential for target date fund names to confuse investors, or lull them into a false sense of security."

She cited her concerns about target date funds advertisements that she said in some cases "perpetuate a 'set it and forget it' mentality, which is concerning."

There is also talk on Capitol Hill of legislation aimed at more tightly regulating target date funds.

What should retirement savers do in the meantime?

My best advice is certainly to consider a target date fund if one is offered through your 401(k) or other retirement savings plan, but compare it to your other investment options and make sure it's an informed selection.

In general, I like the idea behind target date funds, particularly for those uncomfortable about selecting investment options on their own. However, there are several things to check on.

First, what is the asset allocation mix for the particular fund that matches your planned retirement year? Many 2010 fund investors learned the hard way in 2008 that the funds they thought were conservative held as much as 70 percent of assets in stocks. Managers of these funds argue the heavy stock allocation is needed to ensure growth over a retiree's lifetime, which could last 30 years or more after leaving work.

Critics of this aggressive approach, however, say target date funds should be managed to the retirement year, not the investor's potential lifespan. They point to evidence that suggests most retirement savers pull their money out of 401(k) plans upon retirement rather than keep it there.

I can't say what the right portion of stocks is for every investor, but I can tell you that the classic balanced portfolio is 60 percent stocks and 40 percent bonds. A portfolio with more than 60 percent stocks is considered aggressive; less than 60 percent is moving into conservative territory.

If you're uncomfortable with stock allocation tied to your age range, then consider moving up or down the target date scale to adopt either a more conservative or a more aggressive approach.

For an appropriate guideline, you might want to consult the allocations used in the Lifecycle Funds offered through the Thrift Savings Plan, a well-regarded retirement savings plan offered to federal government workers. You find the allocation information at the Thrift Savings Plan web site:

For instance, the Thrift Savings Plan's 2010 fund currently holds about 70 percent bonds and 30 percent stocks. It fared relatively well in the 2008 market crash, losing 10.5 percent for the year.

The second critical issue in examining target date fund choices is expenses. How much will the fund cost you to own? Higher expenses mean you accumulate less for retirement.

According to fund researcher Morningstar Inc., the average target fund expense ratio (on an asset-weighted basis, meaning bigger funds count more than smaller ones) was .69 percent last year. However, this average is heavily influenced by the rock-bottom expenses charged by Vanguard, the second-largest provider of target date funds. It charged an average expense ratio of .19 percent on its target date funds.

This means if you are offered target date funds from anyone other than Vanguard, you could be paying significantly more than the .69 percent average. More than half of the target date funds available charge 1.0 percent or more, according to Morningstar.

My advice is if the target date funds you are offered charged more than .75 percent, then I'd consider other investment options in your 401(k) plan if available. Check to see if the target date funds are more or less expensive or about the same as your other investment options.

One last issue to consider when reviewing target date funds is the fund makeup. Typically, target date funds are constructed using other mutual funds. In some cases the underlying funds might be stellar choices, but in many instances, they're plain dogs. Inclusion in a target date fund can be one way to boost the assets – and as a result the profits -- of an underperforming mutual fund.

If available, give serious consideration to a target date fund that is built with index funds like those offered by Vanguard. This approach should mean lower expenses and less chance of getting stuck with an actively managed fund that has underperformed.

Follow these steps and you're less likely to get caught off guard by your target date fund, no matter what government action results from the 2008 disaster.

This work is the opinion of the columnist and in no way reflects the opinion of ABC News.

David McPherson is a Certified Financial Planner professional and founder of Four Ponds Financial Planning LLC ( in Falmouth and Mansfield, Mass. Contact McPherson at