Target-date retirement funds under microscope

WASHINGTON " Target-date retirement funds are coming under increased scrutiny as investors try to contain the damage to their 401(k)s from the worst economic downturn in generations.

The funds, also known as lifecycle funds, are designed to minimize risk by shifting the funds' assets from equities to bonds as investors grow older. But with their increasing popularity, target funds are also leaving some investors confused about their makeup and about their level of risk. Other investors may not even realize their retirement plan has invested in the funds.

The Senate's Special Committee on Aging is expected to ask the Department of Labor Monday to establish regulations governing the composition and advertising of target funds. It is also planning to request that the Securities and Exchange Commission look into similar concerns.

"Last year, too many 2010 target-date funds reported astounding losses, considering their participants were on the brink of retirement," said Sen. Herb Kohl, D-Wis., chairman of the committee. "It's clear that a number of these companies need to reassess their definition of 'conservative.' "

Under the Pension Protection Act of 2006, companies were able to set target funds as the default option for employees who did not select a plan for their 401(k). Previously, companies could only roll those workers into conservative money market or so-called stable value funds.

That drove a boom in target funds' popularity just as the stock market began to falter. According to a report this month by consulting firm Greenwich Associates, the percentage of retirement plan sponsors that used money market or stable value funds dropped to 19 percent last year from 35 percent in 2007. Plan sponsors that used target funds jumped to 53 percent last year from 35 percent the year before.

Many investors believe choosing a target fund eliminates the need to actively manage their 401(k) because the assets shift automatically over time, said Dean Baker, co-director of the Center for Economic and Policy Research, a think tank. And that can lull investors into complacency, he said.

"They give people a sense of security that probably isn't warranted," Baker said. "They still can be taking on a lot of risk."

Even though the funds were designed to limit aging workers' exposure to stocks, some are still invested heavily in the markets as a worker approaches retirement.

An analysis by the committee found that some target funds were made up of as much as 66 percent equities and as little as 31 percent bonds. Performance was just as varied. The DWS Target Fund 2010 fell just 3.6 percent, besting the market. Meanwhile, the Oppenheimer Transition 2010 dropped 41.3 percent.

The S&P Target Date 2010 Index Fund, which helps investors benchmark their funds' performance, lost 17 percent in 2008. The fund is about 60 percent bonds and fixed-income securities, while the remaining 40 percent is invested mainly in equities.

"There is an extraordinary amount of heterogeneity as you got closer and closer to the target date," said Dallas Salisbury, chief executive of the nonprofit Employee Benefits Research Institute.

Target funds are on the agenda of a hearing the committee on aging will hold Wednesday looking into the impact of the financial crisis on the ability of baby boomers to retire. Falling home prices have wiped out many investors' nest eggs. According to the S&P/Case-Shiller Home Price Index, home values in 20 of the country's largest markets fell 18 percent in November from a year ago, the latest data available. The stock market has fared even worse, with the Dow Jones industrial average dropping about 41 percent over the past year.

Glen Buco, president of West Financial Services in McLean, Va., said he sometimes recommends that clients choose target funds that mature at a different date than they actually plan to retire, allowing them some control over how aggressive their fund is. If they want to take on more risk, they should choose a fund that targets a date after their retirement. If they are conservative, they should opt for one that matures before that date.

Investors can get a sense of the future composition of their funds by looking at those close to maturity, Buco said. But he cautioned that allocation strategies could change and that letting someone else manage your retirement entirely is never a good idea.

"If they were all the same, fine," he said. "But they're not, and that's the issue."