Target Date Funds Gain Despite Critics

Funds, criticized for steep 2008 losses, continue to make large gains in employer retirement plans.

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Target date funds are being provided in a growing number of employer retirement programs, and are being chosen more and more often by employees in these programs, Vanguard said in a new study. Its report summarized 2009 activity among 3.2 million participants in 2,200 defined contribution plans administered by the company.

[See U.S. News's list of the Best Mutual Funds for 2010, and use our Mutual Fund Score to find the best investments for you.] Target date funds are keyed to investors' planned retirement ages. Over time, they automatically adjust their mix of stocks, bonds, and other holdings to create a risk profile, or glide path, appropriate to an investor's changing age. The funds have become increasingly popular default options in many 401(k) plans. The sharp losses they posted during 2008 drew attention to whether the funds were too aggressively invested in stocks and other risky holdings. But they rose by 27 percent in value last year and have continued gains in 2010.

Vanguard and other retirement plan administrators have continued to support the funds as appropriate choices for people with little investment experience. The funds have diversified holdings of stocks and bonds, and adjust such holdings regularly to reflect changing market conditions. Vanguard's study noted, for example, that the rise in use of the funds by investors in the plans it administers was accompanied by a big drop in people who simply let their fund balances sit as cash, earning no investment return.

Vanguard said about a fifth of its plans had adopted automatic enrollment programs by the end of last year but that 40 percent of plans with more than 1,000 participants had done so. Employees are automatically enrolled in such plans unless they choose to opt out, and the default mutual fund investment in these plans has become a target date fund in 90 percent of the plans adopting automatic enrollment.

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Among all 2,200 plans, about 75 percent offered a target date fund choice as of the end of last year, Vanguard said. About 42 percent of participants in such plans held target date funds. Nearly half of these purchases were the result of employee decisions, with the remainder being default investments.

"One of the benefits of target date funds is that they eliminate extreme equity allocations," Vanguard said. It found that 16 percent of non-target date fund investors had no money in equities and 21 percent held only equities; nearly half thus had equity exposure either above 90 percent or beneath 10 percent. "Target date investors cannot hold extreme positions because target date options include both equity and fixed income assets," the company said.

From a market peak on October 9, 2007, Vanguard's target date funds posted large losses until the broad market indexes bottomed out on March 9, 2009. Since then, they've recovered most of those losses. The most conservatively managed funds are actually up from their 2007 peaks.

Target    10.9.07-    3.9.09-        10.9.07-
Year       3.9.09       4.12.10        4.12.10
2005     -25.4%         35.6%           1.1%
2010     -33.0%         45.8%          -2.3%
2015     -38.0%         53.1%          -5.1%
2020     -42.1%         59.3%          -7.7%
2025     -46.0%         65.8%         -10.5%
2030     -49.6%         72.3%         -13.1%
2035     -51.8%         77.7%         -14.3%
2040     -51.7%         77.7%         -14.1%
2045     -51.7%         77.5%         -14.3%
2050     -51.7%         77.6%         -14.2%

[See Target Date Funds Up 27 Percent for Year.]