Target-Date Funds Have Hidden Risks

Senate committee calls for regulation of target-date funds

By SHARE

Target-date funds automatically provide age-appropriate investments that grow more conservative as you approach your designed retirement date. But asset allocation varies widely among funds with similar retirement years.

The Senate's Special Committee on Aging sent letters this week to the Department of Labor and Securities and Exchange Commission asking them to establish regulations governing the composition and advertising of target funds. “Despite their growing popularity, there are absolutely no regulations regarding the composition of target-date funds,” said Herb Kohl, a Wisconsin Democrat and chairman of the committee, at a senate hearing about retirement security. “With more and more Americans relying on 401(k)s and other defined contribution plans as their primary source for retirement savings, we need to make sure their savings are well-protected with strong oversight and regulation.”

A target-date fund designed for someone in their 30's who would expect to retire around 2040 is, on average, 90 percent invested in equities. As an individual gets closer to their designated retirement year, the average allocation to equities is 45 percent. But those averages obscure wild extremes in individual target-date funds. Allocations to equities for employees 10 years from retirement varied from 40 percent to 80 percent among target-date funds in 2006, according to an analysis of by consulting firm Watson Wyatt released earlier this year. On an employee’s retirement day equity allocations ranged from 20 percent to 65 percent. “Target date funds are actively managed funds that vary widely in asset allocation for given stated years,” wrote Dallas Salisbury, president and CEO of the Employee Benefit Research Institute, in his Senate testimony. “This resulted in wide variation in losses in the recent market decline for similarly dated funds.”

The Pension Protection Act of 2006 allows employers to automatically enroll workers in target-date funds. Before 2006, companies generally automatically enrolled workers in more conservative money market and stable-value funds. The share of 401(k) plans using target retirement date funds jumped from 35 in 2007 to 53 in 2008, according to research by consulting firm Greenwich Associates. Meanwhile, the share of plan sponsors using money market or stable value funds as their default investment option dropped to 19 percent from 35 percent over the same period. "Many of these employees began investing, not of their own individual initiative, but rather as a matter of corporate policy," says Chris McNickle, a Greenwich Associates consultant. McNickle points out that this shift to sometimes riskier default investments, which would have helped employees grow their nest egg faster over much of the past two decades, unfortunately coincided with the biggest market collapse in 70 years in 2008. "It's like a bad Greek tragedy," he says.

Tell us, do target-date funds need to be regulated?