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Target-Date Funds: Not a Set-It-And-Forget-It Option

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Since its inception, the 401(k) retirement plan has presented plan sponsors and participants with a significant challenge, requiring both groups to act as financial planners and portfolio managers for retirement investments. Participants are expected to forecast their retirement income needs, arrive at an appropriate asset allocation, and choose among contribution and investment options accordingly. Plan sponsors must create the universe of options from which participants choose and provide advice to participants, but only to the extent that such advice does not give rise to fiduciary responsibility under ERISA (Employee Retirement Income Security Act of 1974). This system has allowed a large number of plan participants to remain uninformed with respect to a very complex set of retirement plan decisions.

The challenge of the uninformed 401(k) participant has been addressed in two recent developments. One is the passage of the Pension Protection Act of 2006, which enables plan sponsors to provide certain types of investment advice as well as default investment options without incurring fiduciary liability. The other development has come from the investment-management industry in the form of the TDF (target-date fund)—an investment fund option designed and promoted to be essentially the final decision a participant should ever have to make with respect to his or her 401(k) plan. By employing a dynamic asset allocation based upon the number of years remaining until a projected retirement date, the TDF offers a “glide path” portfolio, gradually shifting from a higher-risk, equities-weighted mix to a heavier fixed-income weighting as the investor approaches and then enters retirement. After gaining popularity and widespread plan adoption, TDFs are now facing considerable scrutiny, as the recent market turmoil has shed light on some glaring inconsistencies in their performance, design, asset allocation, and marketing. The risks and inconsistencies of TDFs, as well as what are considered suitable allocations, are issues now being grappled with by the industry and regulators. In the meantime a closer look may assist investors and sponsors in their use of this relatively complex investment product.


Over the past several years, TDFs have become extremely popular as an investment choice for 401(k) retirement plans, in large part due to their status as a “default option” in many plans with an automatic enrollment feature. The Pension Protection Act removed a significant impediment to automatic enrollment plans. Generally, the direction of assets into the default investment option is an investment decision subject to ERISA fiduciary requirements. The act provides an ERISA fiduciary safe harbor for allocations into certain types of qualifying investments (known as the Qualified Default Investment Alternatives or QDIAs). TDFs were one of the classes of investments that qualified for QDIA status and were quickly embraced by many plan sponsors as the most suitable default choice. Previously, the primary default option for retirement plans was a money market fund. Due to the complex and overwhelming nature of the investment options presented in many plans, employers found that far too many employees relied on the money market default, allowing their account to languish in a fund paying little interest (Consumer Reports 2008).

The TDF default option is intended to be a set-it-and-forget-it investment, ideal for the risk-averse and uninformed plan participant. TDFs offer a portfolio diversification based on the simple premise that the younger the investor is, the longer the time horizon they have and the greater the risk they can take to potentially increase returns. For example, a young investor’s portfolio should contain mostly equities. In contrast, an older investor would hold a more conservative portfolio, with fewer equities and more fixed-income investments. Accordingly, the TDF asset mix is automatically adjusted over the course of the fund’s time horizon from a position of higher risk to one of lower risk as the investor ages and/or nears retirement (Investopedia). The automatic “easy to use” nature of the TDF, coupled with its QDIA status, has led to its popularity and widespread adoption within 401(k) plans. By the end of 2008, $109 billion invested in TDF mutual funds were held in defined-contribution plans, according to the Investment Company Institute (Singletary 2009).

Figure 1: Total Equity as a Percentage of the TDF Portfolio

  Figure 1: Total Equity as a Percentage of the TDF Portfolio

Data for this chart has been adapted from Target Date Analytics LLC. The “Major Fund Families” include Vanguard Target Retirement Funds, Fidelity Freedom Funds, and T. Rowe Price Retirement Funds. “Current ” applies to TDFs that have passed their target date (such as 2000 and 2005) and are still operating as separate funds, and to those funds in a target-date series that are intended to serve investors in the post-target-date period. Source: Nagengast, 2009.


The problematic performance of TDFs during the market turmoil of 2008 has raised some significant concerns about how these funds are designed and marketed. The funds as a group have exhibited significant overall volatility as well as extreme variability in performance. A big indicator of trouble is in the universe of TDFs with a 2010 target date (marketed to investors expected to retire next year). In 2008 the losses among 31 funds with a 2010 target date averaged approximately 25%, with some of the funds losing as much as 41% (Singletary 2009). For many individuals expecting to retire in 2010, such losses could be devastating and arguably signal much more risk than many of the investors in these funds expected.

Driving much of the TDF volatility are the high-equity allocations typically found in the funds’ underlying portfolios. In 2008 the equity mix for the four largest 2010 funds averaged 52% (Israelsen 2008). Many argue that TDF fund managers have a preference for equities because their higher returns make the funds appear more attractive to potential investors (Nagengast 2009).

Equity allocations vary significantly within the TDF universe. Citing data collected from Morningstar, Mary L. Schapiro, chair of the SEC, recently observed that the 2010 funds currently have anywhere from 21% to 79% in stock holdings (Schapiro 2009). Adding to this variability is the fact that the TDF portfolio mixes are not static. The TDF critical feature, the glide path, determines how the asset mix changes as the target date approaches. Some TDFs have a very steep trajectory, becoming dramatically more conservative just a few years before the target date, while others will have a more gradual approach, remaining more heavily weighted in equities for a longer period of time.

The asset mix at the target date can be quite different as well. Some TDFs are designed for investors who will want a high degree of safety and liquidity; the assumption being that upon retirement the investors will use the funds for their day-to-day needs. Other TDFs assume that the investor will hold onto the funds, and therefore more equities are included in the asset mix, reflecting a longer time horizon; these funds are designed for investors who view their 401(k) plans as a source of inheritance for their grandchildren. In some such cases the glide path has been found to extend as much as 30 years beyond the target retirement date (Nagengast 2009). All of this variability in fund design creates disparities in both the return and volatility within the group, making peer performance comparisons extremely difficult.


The recent volatility experienced in TDFs, as well as the surrounding investor confusion, has caused regulators, sponsors, and industry constituents to reexamine the product, both how it is designed and marketed. In June 2009 there was a joint SEC/Department of Labor hearing on TDFs within 401(k) plans. Comments by hearing participants indicate a widespread recognition of the need for improved disclosures regarding the funds. There was, however, considerable debate over what constitutes an appropriate TDF portfolio design and glide path.

Marilyn Capelli-Dimitroff, chair of the Certified Financial Planner Board of Standards, testified, “We have serious concerns that these funds are fundamentally misleading to investors because they’re allowed to be managed in ways that are inconsistent with reasonable expectations that are created by the titles and the use of the names” (US DOL and SEC 2009). Schapiro, also testifying at the hearing, said, “These varying results should cause all of us to pause and consider whether regulatory changes, industry reforms or other revisions are needed with respect to target-date funds.… Of all of the issues that the SEC is examining at the moment, our review of target-date funds is one that may most directly affect everyday Americans seeking to access our securities markets to help build a better life and a greater sense of financial security for themselves and for their families” (US DOL and SEC 2009).

Despite the fact that the major 2010 TDF managers suffered significant losses last year, they do not see any reason to change the strategy of their funds. Additionally, these managers believe that their investors are knowledgeable and informed about what they are purchasing, as Paulette Miniter reported in SmartMoney. Jonathan Shelon, the comanager of the Fidelity Freedom 2010 Fund, says, “In 1999, we didn’t load up on tech. In 2002, we didn’t load up on bonds. And in ’08, we’re not loading up on cash” (Miniter 2008). He believes that the main concern for his investors is having enough money to live on through the 20 or 30 years after retirement.

Similarly, T. Rowe Price’s TDFs are “designed to carry someone through age 95,” which means the funds “won’t hit their most conservative allocation until that 30-year period after the retirement date,” according to Brian Lewbart, a spokesman for the firm (Miniter 2008). In 2010 the firm’s target date portfolio will still include about 55% in stocks. Managers at Vanguard are of the same opinion. “It’s not as if you’re going to get to 2010 and spend at once, you’re going to spend over many years,” says John Ameriks, head of investment counseling and research at Vanguard. Furthermore, according to Ameriks, Vanguard’s investors “have a general understanding that these are investments, not insurance products or defined-benefit plans” (Miniter 2008).

Notwithstanding the negative aspects of TDFs, the diverse and dynamic aspect of their portfolio design continues to make them a viable option, with potential for improvement. For instance, a Vanguard study found TDFs helped moderate asset allocation extremes. Thirty percent of participants who did not invest in TDFs had 100% invested in stocks, and 16% of the participants had no stocks in their portfolios (as opposed to the TDF average equity mix of approximately 45%). TDFs “are still a very good one-stop shopping option for investors, especially for 401(k) investors who may not have a lot of investing experience,” states Greg Carlson, a Morningstar fund analyst (Jewell 2009).


There is a common misconception that use of a QDIA insulates plan fiduciaries from liability under ERISA in the event of plan participant losses (Bowler 2009). On the contrary, plan fiduciaries are only relieved of liability for the participant’s selection of a QDIA. Fiduciaries are still generally responsible under ERISA for their prudent selection and monitoring of a QDIA investment as well as its ongoing management (DOL Reg. § 2550.404c-5. See also FAB 2008-3 Q&A 1). Accordingly, the selection of a TDF intended to serve as a plan QDIA should be subject to the same due diligence requirements and selection and monitoring processes as other investments offered within a plan. When selecting any type of plan investment option, fiduciaries must take care to investigate and consider the needs of the plan and the best interests of plan participants (GIW Industries Inc., 895 F.2d at 733).

Despite this continued responsibility, TDF design and market risk are very often not fully understood by investment committee members responsible for including them in a 401(k) plan. An Envestnet Asset Management survey of investors revealed that only 16% of survey respondents said that they had heard of TDFs prior to the survey, and 63% of those incorrectly described them (Bowler 2009). The misconception regarding fiduciary responsibility and lack of information about TDFs arguably create increased levels of fiduciary risk in the selection of this complex product.


When selecting TDFs, there are several critical issues for both plan sponsors and participants to consider. At the joint SEC/Department of Labor hearing on TDFs, Karrie McMillan, general counsel for the Investment Company Institute, provided five due The Dangers of Taking a Set-It-And-Forget-It Approach to Target-Date Fundsdiligence questions for investing in a TDF (or selecting one as a plan option). Paraphrased here, those five questions are:

  • What is the meaning of the date used in a fund name? What happens on and after the target date?
  • Is the fund designed for an investor who expects to spend all or most of his or her money at retirement? Or is it designed for an investor who plans to withdraw money over a longer period of time?
  • What is the age group for which the fund is intended?
  • At what point does the fund reach its most conservative asset allocation?
  • Is there sufficient disclosure that investing in a TDF does not guarantee a certain return?

McMillan was quoted as further saying, “Target-date fund investors avoid extreme asset allocations that we often observe in retirement savings, a 25-year-old that holds only cash or a 60-year-old that is fully invested in equities alone” (US DOL and SEC 2009). Accordingly, McMillan continued, TDFs are recognized as providing risk- reduction benefits and, for this reason, have general DOL endorsement.

Plan fiduciaries need to determine if the TDF’s asset allocation and glide path are aligned with their agenda so that the selected TDF is appropriate for plan participants. If they believe that the greatest risk faced by their participants/employees is outliving their retirement funds, they should choose TDFs that use a more equity-oriented glide path. A glide path more heavily weighted toward equities would be appropriate in order to continue to grow assets beyond the target year and overcome inflation. On the other hand, plan fiduciaries that are concerned with protecting participants’ assets should choose TDFs with more conservative glide paths that have their “landing spot” earlier. Other factors that will have an impact upon these considerations include the overall contribution and withdrawal rates and practices of their employees.

Regardless of which TDFs are selected, plan participants should be informed of the risks associated with the TDFs in their plan. For TDFs with equity-oriented glide paths, participants should be made aware that these glide paths often do not find their final landing spot until as much as 30 years past the target date (and are subject to the risk of a significant drop in value even after their retirement). For TDFs with more conservative glide paths, participants should be informed of the modest projected growth levels (which will be subject to the risk of inflation up to and beyond the retirement target date).


Given the complexity of TDFs, plan sponsors face a heightened challenge in properly educating themselves and their participants with respect to the risks and rewards presented. This challenge is made only more difficult where it is not supported by clear and thorough product disclosures provided by the fund companies. Until these issues are resolved and the dust settles, sponsors and participants considering TDFs must stay alert and look hard at what they are buying. Passive investing and a set-it-and-forget-it mentality will not work where there are unconsidered needs and unknown risks.


Bowler, Tom. July 21, 2009. “Use of Target Date Funds in Qualified Retirement Plans: A Primer, Plus Questions Fiduciaries Should Be Asking.” Prime Trust Advisors.

Consumer Reports. August 2008. “The Target-Date Retirement Strategy.”

Doyle, Robert J. April 29, 2008. “Guidance Regarding Qualified Default Investment Alternatives.” Field Assistance Bulletin, no. 2008-03. US Department of Labor.

GIW Industries Inc. v. Trevor, Stewart, Burton & Jacobsen, 895 F.2d 729, 733 (11th Cir. 1990).

Investopedia. “Glide Path.”

Israelsen, Craig L. November 1, 2008. “2010, A Fund Odyssey.” Financial Planning.

Jewell, Mark. January 15, 2009. “Not All Target-Date Funds are Created Equal.” Fox News.

Miniter, Paulette. October 14, 2008. “Target-Date Funds Have Heavy Exposure to Stocks.” SmartMoney.

Nagengast, Joseph C. May 22, 2009. “Target Date Funds—A Good Idea Co-opted.” Securities and Exchange Commission.

Schapiro, Mary L. June 18, 2009. “Speech by SEC Chairman: Address before the New York Financial Writers’ Association Annual Awards Dinner.” US Securities and Exchange Commission.

Singletary, Michelle. July 26, 2009. “Target-Date Funds Can Be Hit-or-Miss.” The Washington Post.

The Standard. December 2008. “Target Date Funds Versus a Managed Approach.”

US Department of Labor and US Securities and Exchange Commission. June 18, 2009. “Public Hearing on Target Date Funds and Other Similar Investment Options.”

US Department of Labor Regulation 2550.404c-5 CFR, Title 29, Chapter XXV, Part 2550.404c-5. October 24, 2007.

–Martin J. Rosenburgh, Esq., is an independent legal advisor specializing in securities and ERISA compliance, and a CFA Level III candidate. Jonathan Miller is an independent financial journalist and a CFA level I candidate. Andrew C. Spieler, PhD, CFA, FRM, is associate professor and director of the quantitative finance program at Hofstra University’s Frank G. Zarb School of Business, and chair of the New York Society of Security Analysts’ Derivatives Committee.

This article was originally published in the Fall 2009 issue of the Investment Professional.

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Where are the investment policy statements for target date funds, which are after all employer directed because the participant is either defaulted into them or limited to the choice made by the employer. Even more importantly, who is driving this bus when it comes to establishing objectives? So far fund companies have set objectives that bear no relationship to a one-size-fits-all vehicle, namely pay replacement and longevity risk.

That's cool that we can take the loans and this opens completely new opportunities.

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