Is Your 401(k) Riskier Than You Think?

What you need to know about target-date funds before you invest.

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Target-date funds sound simple and straightforward: an investor picks the fund closest to his or her desired retirement date and leaves the asset allocation and rebalancing decisions to experienced fund managers. But because of the stinging losses these funds suffered in 2008's financial crisis—the average target-date fund lost almost 34 percent—investors and even the U.S. government have been questioning the transparency and marketing of these popular 401(k) products.

"It was kind of a perfect storm," says Eric Endress, investment analyst at CBIZ Financial Solutions, a national financial services and consulting firm. "All of these employers were taking [target-date funds] up and they were really rapidly growing in the marketplace. Then 2008 happened before these products were really ironed out and marketed properly."

Scrutiny from regulators has increased as a result. A report released in late January by the Government Accountability Office urged the Department of Labor to require 401(k) plan sponsors to assess more thoroughly the appropriateness of particular target-date funds for their employees. The GAO also suggested better education for investors on the strategy, composition, and risks of these funds.

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"A lot of people almost viewed [target-date funds] like they were guaranteed accounts," says Endress. "People were thinking, 'Okay, if I'm in the 2010 account, I'll be guaranteed not to lose money between now and 2010,' when in fact that wasn't the case."

That gap between perception and reality, coupled with wide variations in fund composition and performance history, has muddied the target-date waters further, causing some investors to take on outsized risk for their retirement and financial goals. "There was an assumption that an investor would have a very conservative portfolio at the target date," says Susan Viston, portfolio specialist at ING Investment Management. "That wasn't always the case. It became clear that [target-date funds] have very different philosophies and approaches that can lead to different allocations and wide performance dispersions."

U.S. News talked to the experts to find out how you can avoid surprises in your target-date fund.

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Know the glide path. The trademark feature of target-date funds is a built-in asset allocation model—the so-called glide path—designed to automatically shift from a more aggressive strategy to a more conservative tack as the investor's retirement target year approaches. For example, while a fund with a target date that's 40 years in the future, such as T. Rowe Price Retirement 2050 (symbol TRRMX), might have a stock allocation of almost 90 percent, funds with sooner target dates tend to back off from equities and allot more money to traditionally less volatile asset classes such as bonds. T. Rowe Price's Retirement 2015 fund (TRRGX) has comparatively fewer assets in stocks—about 65 percent—and a heavier allocation to bonds, about 29 percent.

However, wide variations in glide-path structure among fund families have produced very different results, especially for investors closest to retirement. "Some of the target-date providers had allocations to equity between 50 and 65 percent, while others had as low as 30 or 20 percent [at the target date]," Viston says.

Not surprisingly, more conservative funds fared better in 2008's harsh bear market, while investors with more aggressive funds lost almost half of their portfolio's value in some cases. "What a number of firms found was that their allocations to stocks were a little too high and led to losses in a market like 2008 that were greater than they or investors had anticipated," Morningstar analyst Josh Charlson says. "That has led to some shifts in the glide paths, lowering the stock weighting around retirement and actually raising it in the years farthest out from retirement to up the ante and try to get more gains earlier."

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