Pitfalls of automated retirement plans

Target-date funds criticized

Target-date funds have been another trouble spot in the realm of automatic retirement investing. Generally, a target date corresponds to the year in which the investor expects to retire. The fund manager adjusts the asset mix as the target year approaches, reducing the percentage of equities and increasing fixed-income investments to make the overall mix more conservative.

But these funds took heavy fire following the market crash of 2008, when target-date investors suffered large losses. Some funds with an imminent target date fell as much as 50 percent, according to Morningstar, prompting criticisms that the investment mix had been too aggressive.

The controversy prompted the Obama administration to call for target-date fund reforms, including measures aimed at boosting transparency and improving investor education about how these funds work.

"Participants don't always understand target-date funds," says Credico. "Employers are doing more now to communicate that target funds don't offer a guarantee."

One complication is that investment firms have different philosophies about the optimal equity exposure for retirees. "There are broad disparities among target funds in terms of asset allocation," says Christine Benz, director of personal finance at Morningstar. "Some funds are far more aggressive than others. If you are in one of these funds, take the time to understand the asset allocation framework being used and how aggressive it is in its positioning."

Benz adds that investors can get shortchanged because most of the widely available target-date funds are collections of the managing firm's own funds -- and they may not all be top performers within their class.

"Very few firms are equipped to manage all these asset classes well," she says. "So do your due diligence on how the firm has done managing fixed income, domestic equity and international equity. Fixed income is especially important as retirement draws close."

Benz recommends looking at the underlying mutual funds in your target-date fund and doing a quick check on their performance, length of tenure of the fund managers and expense ratios. "Equity funds should be charging less than 1 percent, and bonds should be less than 0.75 percent," she says.

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