Target-date funds disappoint

Should anyone be surprised that "target-date" retirement funds failed to shield investors from the storm last year?

In recent years, these were said to be the savior of 401k plans. The idea behind them was simple enough - just keep piling money into the fund whose name corresponds to the year you plan to retire, and some manager somewhere will take care of the rest by buying you a heavy helping of stocks when you're decades away from calling it quits, then shifting to a heavier weighting of bonds as you get older.

According to this report in MarketWatch, things aren't exactly working out as planned.

Target-date retirement funds were supposed to be the greatest thing since sliced bread. Then 2008 happened. And all of the 264 target-date funds sold by the 39 mutual fund firms that market them performed poorly and contrary to expectations.

Indeed, the most conservative target-date retirement funds - those designed to produce income - fell on average 17% in 2008 and the riskiest target date retirement funds - designed for those retiring in 2055 - fell on average a whopping 39.8%, according to a recent report from Ibbotson Associates, a Morningstar company.

Not a single target-date fund had a positive return, according to Tom Idzorek, Ibbotson's director of research and author of the report.

As if there wasn't already enough working against conventional wisdom when it comes to retirement planning, you get results like this.

If I still had a 401k, the bulk of it would probably still be in one of those stable value funds - they always seemed to produce a decent positive return even in the worst of times, but then you never know which insurance company is going to run into trouble these days.

Apparently, no matter how close to retirement you were - at a point in your life where you want stable income - the target-date funds failed.

But what was especially troubling, according to Idzorek, was the disparity in performance among funds for those in or near retirement. Target-date funds designed for those retiring in 2010 -- next year -- were all over the map. The best of the 31 funds with 2010 in their name fell 3.5%, while the worst fell 41.3%.

What gives? To understand the problem, you have to get under the hood of these funds. In short, target-date funds are collections of other mutual funds actively managed by an adviser. Typically, the adviser buys a mix of stock and bond funds, usually from the in-house fund family, and then adjusts the mix over time, reducing the percentage invested in risky assets -- stock funds -- the closer the fund gets to its target date.

But every fund firm has a different take on what a target-date fund is and how it should be managed. Each firm has its own theory on what the mix of stock and bond funds should be. And each firm has its own theory on what's called the glide path, how the mix of stock and bond funds should change as the fund nears its target date.

Thus, funds with the same target date could have entirely different stock-bond mixes: one firm's 2010 might have 20% in stocks while another's could have 40%.

There's a good discussion of risk tolerance and risk capacity at the end, though nothing on the subject of "risk" that is anywhere close to the inanity of this item from a couple weeks ago.

The entire piece is well worth a look.