Target-Date Funds, are they appropriate?

In the last few weeks much scrutiny has befallen Target-date funds culminating in the June 18th hearing of the Securities and Exchange Commission and the Department of Labor. The hearing came about because the diverse range of returns (losses) since the great recession began in the fall of 2007 with similar dated Target-date funds with different investment firms.

Target-date funds invest in a mix of equities, fixed income and cash equivalents that automatically rebalance toward a more conservative mix the closer the fund gets to it retirement date. This is accomplished by systematically reducing or glide path, and replacing these investments with more conservative, less volatile asset classes such as bonds, inflation protected securities and cash. The glide path dictates at what ages, and to what extent, the asset allocation is modified, in effect transferring the onus of portfolio management and rebalancing to a professional money manager.

Target-date funds have because very popular after being one of the default investment options for 401(k) plans per the the 2006 Pension Protection Act. Target-date fund assets went from $66 billion in 2005 to $178 billion in 2007 but it is now down to $152 billion in March 2009 due largely to the beating they took during the market downturn. In a recent speech SEC chairperson Mary Schapiro expressed her concern that the average loss last year for 31 funds with a 2010 retirement date was almost 25%, with losses ranging from 3.6% to 41%. This is quite a hit for those nearing retirement. They probably won't have enough time to recover.

According to a recent research report from Vanguard there are three factors that determine the funds' glide path and widely varying returns;

1. Asset Allocation - higher funds' allocation to stocks the more aggressive the fund.
2. Underlying Asset Classes and exposure to each - examples would be %US stocks compared to % international stock and with bonds corporate bonds % compared to % US Treasury bonds.
3. Implementation - active versus passive methodology. Active managed have greater potential for higher return but at a higher risk. Active managed also have higher expenses.

To see an example of a Vanguard's glide path please click on the link.

Even with the volatility that we have seen from this severe down financial market I still think Target-date funds are very appropriate investment for a retirement account for their simplicity and rebalancing methodology. But it does raise the issue of the appropriateness when one is nearing retirement. Make sure you understand the above three points especially the Asset Allocation. Some Target-date funds are very aggressive even when one is nearing their retirement years.

If you want little involve in investing your retirement balances a Target-date funds would be appropriate. Another name for Target-date funds are lifecycle funds