Target-date funds miss mark for many investors

Target-date funds were supposed to be the solution to the nation's looming retirement crisis, not money-destroyers.

With Americans not saving enough for retirement, and too many making poor investment choices, the funds were established to be no-brainer 401(k) choices.

Congress gave companies the go-ahead in 2007 to automatically put a little money from their employees' paychecks into the funds in 401(k) plans, and let the funds get the individuals ready for the day they would retire.

Investors added money of their own, embracing the simple concept of giving a professional their retirement date and then having the pros choose stocks and bonds.

But then came the stock market crash of 2008, and people about to retire in 2010 lost an average of 23 percent of their savings. It was a shock to people who thought target-date funds made their money safe as they approached retirement.

Congress held hearings, and critics said the target-date funds were fundamentally flawed.

Now, a year after the target-date funds went from darlings to villains, many individuals have regained a good portion of what they lost, and the cry for government intervention has eased.

But as the Department of Labor and the Securities and Exchange Commission work on disclosure guidelines and other rules for employers and fund companies that offer target-date funds in 401(k) retirement savings plans, new research from Morningstar Inc. suggests that Congress probably was too quick to give the volatile funds the government's blessing.

Morningstar researchers said target-date funds are far from the simple funds many envisioned. The complexity is apparent in the differences among funds carrying the same target retirement date. With the variety, risks are more extreme in some funds than others.

Stock exposure differs dramatically, from more than 65 percent to roughly 25 percent stocks in 2009 for funds aimed at people who intend to retire this year. And other risks vary as well. Morningstar notes that certain funds performed poorly, in part, because of investments in toxic mortgage bonds.

Chris Tobe, a pension consultant and critic, has testified in congressional hearings that fund companies loaded too much stock into funds intended for near-retirees because the companies make more money on stocks than bonds.

Morningstar analysts aren't convinced that has been the issue. Rather, they note that during the rising stock market between 2003 and 2007, fund companies competed to win lucrative 401(k) business. Adding more stocks boosted returns in the funds and attracted employers. According to the SEC, the fast-growing target-date fund business totaled about $240 billion last summer, compared with $10 billion a decade earlier.

In addition, Morningstar noted that the industry was fixated before the market downturn on the concern that many Americans will live for decades in retirement and could run out of money unless they bolstered their savings by investing in stocks.

Morningstar concluded that target-date funds have worked well for young savers who stuck with their investments despite sharp losses, but failed people on the verge of retiring. Flows out of the funds indicate many nervous pre-retirees never imagined such sharp losses and fled, missing the upturn that followed.

That finding is no surprise to Jodi DiCenzo, a partner in Behavioral Research Associates, who recently completed a study of investors for Envestnet, an investing consulting firm.

"Investors don't have a clue about target-date funds," she said. "And target-date funds give people a false sense of security."

After reading the marketing material that fund companies provided on the funds, 62 percent of 401(k) investors she surveyed thought target-date funds would make it possible for them to retire on the date they planned, regardless of how much money they saved, and 32 thought they would earn a guaranteed return. About 41 percent didn't realize they could lose money over a year, even though it's common for people to lose money in funds that include stocks, as virtually all target-date funds do. Roughly 57 percent didn't think they could lose money over 10 years.

Individuals need better education, she said, because people do not realize the losses they can incur during downturns. And employers are failing workers by focusing on investments to prepare for their future.

"They must be told the most important thing they can do is to save more," she said.

Gail MarksJarvis is a personal finance columnist for the Chicago Tribune and author of "Saving for Retirement Without Living Like a Pauper or Winning the Lottery."

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