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For Some Target Funds, History Repeats

Despite their widespread popularity in company 401(k) plans, target-date funds’ history has been plagued by controversy.

As SmartMoney.com reported on Monday, the premixed portfolios, which get more conservative as the “target  date” approaches, faltered in 2011. The average fund with four years until its target date fell 0.4% and trailed many stock and bond indexes. Indeed, many savers nearing retirement once again found themselves with too much exposure to equities, says Mike Alfred, co-founder and CEO of BrightScope, an independent rater of 401(k) plans.

But this isn’t the first time the funds have come under scrutiny. Sure, for many years, the funds were considered a great retirement fix for busy Americans, designed as they were to make saving simple. And while the funds have been around since the mid-1990s, they didn’t become a popular option with retirement savers until the Labor Department basically blessed the funds: Under the Pension Protection Act of 2006, target-date funds are one of the few default options available for employees who are automatically enrolled in their company 401(k) plans.

During the market rout of 2008, however, many target-date funds suffered severe losses, even for investors who were planning to retire in a few years. The failure of these funds to protect 401(k) participants  prompted the Department of Labor and the Securities and Exchange Commission to hold a joint hearing on what, if anything, should be done about the funds. For example, some critics of the funds advocated limits on the amount of stock exposure the funds can hold, especially as they near their target.

In response, many 401(k) providers increased their fixed-income holdings. For example, of the 45 funds with a target date of 2016 to 2020 tracked by investment-research firm Morningstar Inc., the average had about 32% in bonds and 56% in stocks in March of last year – up from 25% in bonds and 67% in equities.

And the funds became an even more-popular option for retirement plans. Because they invest in a mixture of stocks and bonds and adjust allocation automatically, the funds were a good fit for investors who were unlikely to take charge of their own investments, says Craig Copeland, senior research associate for the nonprofit Employee Benefit Research Institute. “They caught on and at some point they caught fire,” says Alfred. Today, they have $368 billion in assets, more than double the amount they held in 2008.

The portion of 401(k) assets in target-date funds nearly doubled to 11% at the end of 2010 from the end of 2007, according to the most recent data available from the EBRI. The funds are especially popular among new employees, making up 44% of account balances for recently hired participants in their twenties, up from about 7% in 1998, according to EBRI. As SmartMoney previously reported, some 90% of retirement plans that automatically enroll employees put new investors in target-date funds. And once people invest in a target-date fund, they’re likely to stick around: 95% of investors automatically enrolled into the funds in 2007 were still invested in them two years later, according to EBRI.


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