About half of American workers who participate in 401(k) plans have at least some of their money in so-called target-date funds, which continually rebalance portfolio assets throughout one's working life to maintain an age-appropriate level of investment risk. The premise of targeted funds is that the closer to retirement we get, the less risk we want in our portfolios. Targeted funds put the investor on a "glide path" to retirement that involves gradually supplanting riskier, growth-oriented assets with supposedly safer, income-generating holdings, so that by the target date, you're holding some optimal level of risk.
But do investors in these funds really understand what they're getting? Target-date funds are under a bit of pressure these days from federal regulators proposing stronger disclosure rules regarding their investment strategies and marketing practices. However the rules end up, though, it's probably best for workers to be sure for themselves exactly what they're invested in.
Issues surrounding investors' understanding of the funds arose following the crash of 2008-09, when many short-dated funds (those geared toward investors nearing their retirement date) did about as badly as the overall market, confounding older investors who'd thought they were better protected. In 2010, the U.S. Department of Labor proposed rules that would require marketing materials to provide more-prominent disclosure about how target-date funds work. Among other things, the rules would require "tagline disclosure"—stating the target date adjacent to the first use of the fund's name. For example, The 2030 ACME 40/50/10 fund would denote a fund that aims to hold 40 percent in stocks, 50 percent in bonds and 10 percent in cash by the year 2030. Funds would also have to provide both narrative and graphical explanations of how the asset allocation will change over time.
As the proposal gestates, a survey of investors commissioned by the Securities and Exchange Commission has found substantial confusion about how the funds work. For example, fewer than a third of total respondents (about half of whom own target-date funds) understood, correctly, that the year in a fund's name refers to the point when the investor stops purchasing shares. Some 30 percent of target-fund owners (and 12 percent of non-owners) believed incorrectly that the target date is when the asset allocation is at its most conservative.
Also, while substantial majorities understood correctly that target-date funds hold a mix of stocks and bonds and that the mix changes over time, about a third believed incorrectly that they promise guaranteed income at retirement and that the mix stops changing at the target date. Not necessarily; it depends on the fund.
The fund industry has mixed views about the proposed changes. The Investment Company Institute, the industry's business association, generally applauds them, though it says tagline disclosure puts too much emphasis on the end game and not enough on how you get there. "In order to avoid investor confusion and to help investors understand that there is more to a target date fund than its asset allocation at the target date, this information should be introduced in its full context, not initially in a tagline," the ICI wrote in comments on the Labor Department proposal.
Others doubt tighter rules will make much difference for most investors. "I don't really think disclosing the asset allocation at that date would really help them that much to figure out which target-date fund would be best to get them to retirement," says Robert Hiltonsmith, a policy analyst at the progressive think tank Demos and a longtime critic of the whole 401(k) system. Aside from the relatively high fees target-date fund charge, "there's only so much disclosure can do when you get at the fundamental issue of [investors] not being able to make the right decisions with whatever information is at their disposal."
Investors sophisticated enough to have specific allocation preferences can probably build their own portfolios with low-cost funds and ETFs, some argue. What's more, tagline disclosure says little about what happens between now and retirement, or what stocks an equity allocation actually contains.