The popularity of target date funds in company 401(k) retirement plans shows no signs of slowing down, based on the latest data from U.S. investment companies reporting more workers using the “set-it-and-forget-it” approach to retirement investing than ever before.
According to the most recent data available, at the end of 2012, 41 percent of all company 401(k) plan participants owned mutual funds that automatically adjust an employee’s mix of investments to be more conservative as the target retirement date approaches, according to a recent report by the Investment Company Institute and the Employee Benefit Research Institute, both based in Washington, D.C.
That represented an increase from 39 percent using the funds in 2011 and 19 percent in 2006.
“This is a market solution responding to the range of individuals that are investing in 401(k) plans,” said Sarah Holden, senior director of retirement and investor research for the ICI.
Target date funds, also known as life cycle funds, have taken the retirement planning industry by storm, partly because they have made it so much simpler for Main Street investors. Workers choose the year they wish to retire, then pick a fund with a date closest to the target – such as a 2040 target date fund for someone planning to leave the workforce in 2038.
As that date approaches, the fund becomes more conservative, automatically lowering the percentage of the portfolio invested in stocks and shifting to a higher percentage of bonds and cash so that the likelihood of big losses will be reduced.
One reason the funds have become more prevalent in 401(k) plans is because the U.S. Department of Labor has designated them as qualified default investment alternatives.
That means employers are protected from liability if they invest an employee’s contributions in a target date fund in cases when that employee has not otherwise made an investment choice.
“It’s about convenience, diversification and the ease of matching up your expected retirement date with a reasonably asset-allocated and appropriate portfolio,” said P.J. DiNuzzo, president and chief investment officer at DiNuzzo Index Advisors in Beaver Borough, Pa.
There are plenty of the funds to choose from. ICI’s 2013 fact book tallied 1,156 target date funds with $1.3 trillion in assets by 2012, compared with 603 target date funds with $470 billion in assets in 2006.
But critics of target date funds say the sweet and simple concept of a one-stop retirement solution lulls individuals into a false sense of security.
Target date funds did not fulfill their promise to many people who had planned to retire in 2010 following the tumult of the financial crisis of 2008. That prompted the Securities and Exchange Commission to take a closer look at how target date funds were being managed. The SEC eventually proposed new rules requiring the managers of such funds to start spelling out exactly how they are investing the money.
Dan Dingus, director of portfolio management for Fragasso Financial Advisors in Pittsburgh, said the firm uses target date funds in employee directed retirement plans, but never exclusively.
“They merely offer a complement to core retirement plan investments for those participants who either want to do it themselves or follow a model,” Dingus said. While target date funds can be helpful, he said, they fall short in some areas.
“Each fund family has its own definition of what an asset-allocated portfolio should look like,” Dingus said. “In 2008, some firms believed higher equity allocations vs. fixed income were appropriate across their suite of retirement dated investments. As such, they suffered more than others who may have held less equity.
“It’s not that one is better or worse than the other. You merely need to understand what the fund group’s philosophy may be.”
Those concerns are shared by Curt Knotick, CEO of Accurate Solutions Group in Butler City, Pa.
With so many different target date funds available, all with different costs and different allocations, it becomes harder for individuals to choose one that fits their needs.
“You have to compare how often it is rebalanced, what fees are involved and how conservative it is,” Knotick said.
“Regardless of your target date, the funds can still vary in how conservative or aggressive they are, and you want to make sure your fund fits your risk profile. These ‘default’ investment strategies are not designed to meet an individual’s unique risk tolerance or financial goals, but rather appeal to a large segment of consumers.”