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Your Money

The Great Target-Date Debate

Can these funds protect you against loss, but give you the growth you need in retirement?

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— Zack Seckler/Galery Stock

Target-date funds were promoted as an easy, solid road to retirement, taking the guesswork out of investing. You pick a retirement date and the funds choose asset allocations for your portfolio based on that date. The closer you get to retirement, the more conservative your investments become.

But with the onset of the recession, these funds’ performance has been anything but stable. Many funds targeted at people eyeing retirement this year took a severe beating in 2008, particularly in the fourth quarter. Some funds lost as much as 41 percent of their value as markets plunged.

The funds' losses during the recession have drawn criticism from research groups such as Morningstar. Research by the Employee Benefit Research Institute (EBRI) in Washington has found that some 401(k) participants also invest in target-date funds along with other 401(k) funds, which may have unintended consequences for their potential risk and reward. The Obama administration’s Task Force on the Middle Class called for further review of target-date funds and clear disclosure about their risk of loss.

Industry executives continue to defend the funds, saying that attention has focused unfairly on ones with the steepest drop, with little attention going to subsequent recovery. While the U.S. stock market suffered a decline of 38 percent, the average 2010 fund was down about 24 percent, says John Ameriks, a principal at Vanguard Investment Counseling and Research.

The executives say that many investors don’t properly understand how target funds operate. And that even with the losses, target-date investors did better than they would have if they’d been managing their money on their own.

Some funds have been restructured since the market crash. Charles Schwab Investment Management revamped its target funds in April 2009 to place greater emphasis on fixed income investments. But the company says that the changes were in the works even before the market volatility and were not a direct result of it.

According to Daniel Kern, managing director and portfolio director at Charles Schwab Management Investment, the reason was “more of a realization that retirees or folks nearer retirement really need more preservation than growth, hence the increase to fixed income.”

Popularity started in 2006

Target date funds got a big boost in 2006 when the Labor Department designated them as eligible default investments for defined contribution plans. That meant that employees who declined to select their own investments could be automatically enrolled in these funds, which combine a broad range of stocks, bonds and other investments.

According to data compiled by EBRI and the Investment Company Institute, by the end of 2008, 15.4 million people held about $161 billion in target-date funds in their 401(k) accounts. Some projections show the funds surpassing $1 trillion by 2013.

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