'Safe' Target-Date Retirement Funds Have Hidden Risks

You might not realize that stock allocations vary wildly in these portfolios.

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Target-date retirement funds are designed to automatically shift investors' portfolios to less risky assets as they age. You name your retirement year, and the fund managers change the stock and bond allocation inside the fund to an appropriate risk level for your age, in theory getting a bit more conservative as you approach your ideal retirement date.

Almost 80 percent of large U.S. plan sponsors offered target funds as an investment option through their 401(k) plans in 2007, up from 60 percent in 2006, according to research by consulting firm Greenwich Associates. And even if you don't sign up, you could find yourself automatically enrolled in them unless you specifically opt out. "About 40 percent of funds that have adopted automatic enrollment use target retirement date funds as their default, compared with about a third using money market funds," says Greenwich Associates consultant Rodger Smith.

But an "age appropriate" level of risk is open to interpretation. A recent analysis of target-date funds by consulting firm Watson Wyatt found that allocations to equities for employees 10 years from retirement varied from 40 percent to 80 percent among target-date funds in 2006. And equity allocations for employees on their retirement day ranged from 20 percent to 65 percent. A Morningstar Direct report found that some funds for employees expecting to retire in 2010 still have almost 70 percent of assets in equities. "The lack of consistent philosophies in this area means that products with very similar names can have very different compositions," says Robyn Credico, national director of Watson Wyatt's defined contribution practice.

Just remember that when you choose target-date funds, you give up control over your investment and can't make your own changes, even if you end up retiring earlier than planned. Please share your target-date fund experiences below.