Target Date Funds: Hit or Miss?

Introduced as a default choice for 401(k) plan participants after years when gazillions of dollars were poured into low- or no-yielding money market funds, target date funds are designed to automate asset allocation. The funds rejigger the mix of stocks, bonds, and cash for plan participants based on their age. In theory at least, a younger person would have a higher concentration of stocks, which are more volatile than bonds, while an older person closer to retirement would have more bonds in an effort to preserve principal. Easy.

But these funds have received some scalding criticism, triggering at least one Senate hearing (the most recent was in October, as of this writing) and increased scrutiny from the Department of Labor, which regulates the nation’s pension plans.

Nevertheless, investors continue to pour billions of dollars into these vehicles. Assets now invested in target date funds total $256 billion, according to a recent Morningstar report.

Kent Peterson is senior associate actuary and director of investment services for Securian Retirement, a unit of St. Paul–based Securian Financial Group. He recently issued an eye-opening white paper on target date funds. The upshot: These funds aren’t the carefree options they’re purported to be.

Why did target date funds become so popular? What is their appeal?

Peterson:Retirement plan participants have traditionally struggled to allocate their money into appropriate investments based on their risk profile and time until retirement, and plan sponsors have always struggled with how to educate their employees. No matter how much time and energy and money they spent on it, they never seemed to bear any fruit.

So when target date funds came out, I think plan sponsors gravitated to them because rather than having to educate, it was a do-it-for-me solution.

All right, so it’s almost like a black box that worked?

Peterson: Yes, it was a black box that felt like all you had to do was answer ‘when’ questions, [like] ‘When am I going to retire?’ And from that, [participants] got put into a diversified array that would be appropriate for their particular age.