One Size Doesn't Fit All
In addition to this regulatory stamp of approval, target-date funds offer an appealing solution to an intractable problem: how to turn the average employee into a discerning investor. Most employees have a limited attention span for investment education. "We have about an hour to explain the importance of saving, why the 401(k) plan is the best way to do that, and basic investing concepts: what a stock is, what a mutual fund is," says Thad Hamilton, vice president of TRI-AD, a 401(k) administrator and record-keeper. "By the time you get to the difference between large-cap value and small-cap growth, you've lost them. A target-date fund with a good glide path makes it easy: 'You're retiring in 2020? Here's a 2020 fund.'"
Not surprisingly, a professional manager often makes better allocation and rebalancing decisions than a participant would. A Vanguard Group study of more than 1,300 401(k) plans compared risk-taking between investors in target-date funds and those not investing in such funds. The analysis of non-target-date investors found large concentrations of participants with either extremely conservative or extremely aggressive portfolios. The target-date investors had a range of portfolios that were consistent with long-term investment principles. "Target-date funds eliminate the extremes, improve diversification, and add automatic rebalancing," says Stephen P. Utkus, a principal at Vanguard Center for Retirement Research.
But as their detractors point out, they are one-size-fits-all: everyone who chooses the same retirement year gets the same portfolio. "That's a big reason we're not comfortable with target-date funds," says Tom Dunn, CFO of Southwest Power Pool, a regional transmission organization in the electric utility industry. Instead, the company's 401(k) opted for a slate of traditional funds, which its investment adviser has used to create five customized portfolios based on risk preferences. "If you're a 55-year-old who has zero dollars saved for retirement, I don't think you want the same portfolio as a 55-year-old who has $2 million," says Dunn.
A more serious flaw is that regardless of investors' age, there's no consensus on what constitutes a good portfolio mix or glide path. A glide path doesn't lend itself to benchmarking, explains Idzorek. There is no standard, because what's best really depends on the individual investor's circumstances and preferences. Nor is there any regulatory guidance. "There are absolutely no regulations regarding the composition and marketing of target-date funds," says Sen. Herb Kohl (D–Wis.). That may soon change. Kohl has asked the Labor Department and the Securities and Exchange Commission to address the matter.
Meanwhile, the popularity of target-date funds provides plenty of incentive for investment firms to continue to refine, and more clearly define, their offerings. No doubt there is room for improvement. Companies can help drive some improvements by asking more and harder questions about how these funds are designed (and why), and by making sure that the information provided to employees about such funds doesn't stress their simplicity to the point where inherent risks go unacknowledged.
Lynn Brenner is a freelance writer based in New York City.
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