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Target Date Retirement Funds: A False Sense of Confidence?

Investors are confident. At least they are if they are invested in a target-date retirement fund. Nearly three out of four target-date fund investors say they are more certain about reaching their retirement goals, according to a new survey by ING.

That sense of security has investors pouring money in. Target-date assets have grown from $15 billion in 2002 to $363 billion 2011. And last year alone, target-date funds saw inflows of $31 billion.

But those inflows might be based on a false sense of security. While target-date funds have been billed as a simple one-stop solution to retirement, it’s not quite that easy.

The name is self-explanatory: target-date funds are mutual funds that are focused on a future date. The fund’s assets are allocated based on a pre-set time horizon to reach the retirement date. Early on, the holdings are more aggressive. As the target date approaches, the fund becomes more conservative. The change in allocation over time is called the fund’s “glide path”.

That sounds straightforward enough. But it’s not. Target-date funds vary widely in their glide path…so two different funds might have the same target retirement date, but very different levels of risk over time. For example, one fund may start with a 90% allocation to stocks at the outset, but still holds 60% stocks at the retirement date.

And another fund with the same target date may begin with a 75% allocation to stocks, and taper down to 25% by retirement.

A lack of risk management is a problem. Because target-date funds have a pre-set asset allocation schedule, they don’t respond to market currents…in other words, there is virtually no risk management. When a fund’s road map is drawn at the beginning, it can’t adjust to changes in the market climate or shield investors from volatility.

Investors need to distinguish between active risk management and glide-path implementation…the two are not the same. But few investors make that distinction: the ING survey showed that just 36% of target-date investors could describe a glide path. And just 55% of respondents were aware of the changes in their funds glide path.

According to ING, target-date funds, when effectively designed, can bridge “the gap between investor knowledge and long-term retirement objectives”… or in some cases, they just cast a fog over the gap and create an artificial sense of security.

Also according to ING, “target-date funds have evolved as a way to make saving for retirement easier and more automatic for the average plan investor”. I can’t argue with that. But sometimes, easy and automatic amounts to blindly taking a pre-charted route and having your risk tolerance decided for you.


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