July 12, 2009
The ongoing and sometimes contentious debate over whether target-date funds have "failed" is missing some important points.
Target-date funds, the leading "default" option in workplace 401(k) plans, are mutual funds designed for people retiring in or close to a particular year.
Their attraction: Rather than struggle to pick the right mix of funds and manage them, you choose a single, broadly diversified fund. As the "target" date approaches, it gradually shifts money from stocks into bonds and other fixed-income investments.
These funds exploded in popularity in 2008, with assets approaching $250 billion, after the U.S. Department of Labor blessed them as "default investment alternatives" in 401(k) plans.
Under the Pension Protection Act of 2006, that meant employers could direct employee contributions into target-date funds if the employee did not specify a choice.
Long term, choosing diversified funds for our retirement savings makes sense. But diversification has been no shield in this brutal bear market. With stocks and corporate bonds tumbling, even target-date funds designed for people retiring as early as 2010 lost nearly 23 percent of their value on average in 2008, pushing overall target-fund assets down to $164 billion at year-end.
So, lawmakers, regulators and consumer groups have thrown around a number of proposals, including standardizing the stock/bond mix of target-date funds, which varies widely among fund companies; capping how much they can put into stocks near their target date and creating different versions, from conservative to aggressive, of same-year funds.
Target-date funds can be important building blocks in our retirement savings plan. But we may want or need other components, such as cash reserves and accounts designed to generate income streams, such as bond ladders or income annuities.
We also should not brand target-date funds as "failures" based on one year's results.
The 2008 bear market "is a short-term snapshot within decades of retirement saving and withdrawals," said Jerome Clark, lead portfolio manager of the T. Rowe Price Retirement Funds, in the company's spring newsletter. Clark said T. Rowe Price research continues to support the firm's relatively heavy stock allocation (55 percent to stocks on the target retirement date, declining to 20 percent 30 years after retirement) so the portfolio can grow and keep up with inflation.
Humberto Cruz is a columnist for Tribune Media Services. E-mail him at firstname.lastname@example.org.
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