The Rock ‘n’ Roller Coaster at the Disney resort in Florida features a frightening version of the L.A. freeway, where you go from zero to 60 miles per hour with the force of a supersonic F-14 Tomcat, accompanied by high-decibel heavy metal music by Aerosmith.
It’s a ride unlike any you’ve ever experienced — unless of course, you count the one provided by the stock market this year.
After enduring several months of mostly negative volatility, a lot of investors would like to get off the ride. I don’t know about you, but I’m getting nauseous.
Baby boomers who were smart enough to invest in target-date funds — those no-brainer, one-size-fits-all vehicles that automatically shift to more conservative investments over time — have escaped a lot of the tumult, right?
Not exactly. You can expect those with a date of 2020 or later to get hit hard, since they’ll have a lot of equity exposure by design. But many with a target date of 2010 — that’s a little more than a year away — have been reeling in this market environment, with losses ranging from 15 percent to more than 40 percent year to date. Eeeeeeeeeeeeee!
What gives? These funds are supposed to shed stocks and purchase bonds as the target date approaches, or at least that’s what the fund marketing literature says. Yet some of these 2010 target-date funds have high stakes in stocks.
Close inspection of a 2010 fund
If you’re invested in AllianceBernstein 2010 Retirement Strategy, for example, you would have nearly two-thirds of your portfolio exposed to stocks, 31 percent in bonds and 3 percent in cash equivalents, according to Morningstar. And your fund would have lost 37 percent in the 12 months through mid-November.
Ironically, AllianceBernstein published several research reports recently in which it characterized the target-date funds of leading competitors as too conservative and not properly diversified, according to Forbes.com.
“Some shops like AllianceBernstein, which has some of the most aggressive target-date funds around, have done a lot of work on this,” says Morningstar fund analyst Greg Carlson. “They’ve used Monte Carlo simulations. There’s a lot of research backing what they do.”
Monte Carlo simulations involve running different portfolios through thousands of market scenarios to see which combination of equities, bonds and money market funds would improve the probability that a portfolio would last as long as you do.
“The high level rationale is that there is a trade-off between the risk of losing principal, and a concern about the risk of not having enough accumulated to last through retirement or keep up with inflation,” says Nevin Adams, editor in chief of plansponsor.com, which advises benefits and retirement decision-makers.
“They (investment firms) also argue that people generally aren’t going immediately from working full time to not working at all; they’re extending their working years,” Carlson adds. “So they’re not going immediately from a big accumulation phase to a big distribution phase.”
Right now it appears that many boomers approaching retirement age really don’t have a choice. They’ll have to extend their working years out another five or 10 years, either because they haven’t saved enough, their investments have contracted sharply — or both.
In fact, that’s largely the perception among many employers who offer retirement plans (also known as plan sponsors). In a recent survey of 1,089 plan sponsors, nearly half (46 percent) say their plan participants are considering a delayed retirement because of the recent economic turmoil.
Just for the record, AllianceBernstein’s fund performance is not the worst of those sporting a 2010 target date. That dubious honor goes to Oppenheimer Transition 2010, which plummeted 42 percent in the 12 months ending November 14, compared to -39 percent for the Standard & Poor’s 500. Ouch!
A little background
Beginning in 2008, target-date funds get safe harbor protection as qualified default investment alternatives, courtesy of the Pension Protection Act. That means that if you don’t get involved in choosing investments yourself, employers who offer automatic enrollment can throw your retirement contributions into a target-date fund without fear of legal ramifications — for the most part.
Roughly 30 percent of employers provide auto-enrollment, according to plansponsor.com. The breakdown of default investments used by companies with auto enrollment is as follows.
Hed: Default investments in 2008
By far, target-date funds are the most common default option, and they’ve grown in popularity in recent years. “It’s worth noting that in last year’s survey, target dates were the default in 33 percent of plans,” says plansponsor’s Adams.
Will lawsuits emerge?Because target-date funds are sanctioned by the Department of Labor, employers don’t have to worry too much that they’ll be liable for market losses, at least theoretically.
However, some employers do have furrowed brows. Adams says that as part of its annual Defined Contribution Survey, employers were asked, “How concerned are you about litigation resulting from auto-enrolling participants into target-date funds where the underlying funds do not meet the IPS standards?”
IPS stands for investment policy statement, and this has been likened to an architectural blueprint for retirement plans.
Says Adams: “Over one in five (plan sponsors) were ‘very concerned,’ 43 percent were ‘somewhat concerned.’ Only about a third were ‘not at all concerned.'”
It turns out that a lot of plans don’t even have an investment policy statement in place, according to plansponsor’s Defined Contribution Survey.
Planadviser magazine reports that some 30 percent of plans that don’t use an adviser don’t have an investment policy statement. Among those plans that do use an adviser, 26 percent don’t have an IPS. An IPS provides guidelines to employers about when to drop investments that don’t meet certain criteria. Without guidelines, it’s difficult to properly monitor investments. Yet it’s the fiduciary duty of plan sponsors to put in place a process to select and monitor appropriate investments for plan participants.
Plans are not required by law to adopt an IPS, but without one they are more vulnerable to lawsuits.
Design your own IPSOne reason target-date funds are all over the place as far as performance and investment strategies go: There’s no ideal portfolio design that everyone follows. Some target funds do get more conservative as the target date approaches, while others stay quite aggressive. But it’s likely that the horrendous performance of some funds may get the attention of the Department of Labor.
Meanwhile, says Morningstar’s Carlson, “I do think that there’s a real lesson to be had here for investors to really approach those most aggressive funds with caution.”
What can investors do to protect themselves?
“In general, they have to peek under the hood to see what the asset allocation is and consider whether that fits in with their goals and risk tolerance,” says Carlson. “Look at the equity exposure, look at the funds as well. Look at the costs.”
If you’re not happy with the asset allocation of a target-date fund, review the other investment options in your plan. Divert a portion of your contribution to other funds so that you achieve the ideal asset allocation that meets your criteria.
But don’t stop investing altogether, and don’t move everything over toultra conservative investments unless you’re unable to sleep at nights. History tells us that it’s only a matter of time before the markets will rebound, and you don’t want to miss out on that ride of positive volatility when it finally happens.
|Target-date 2010 funds from select fund firms|
|AllianceBernstein 2010 Retirement Str||-36.67||-7.6||0.94||65.47||30.9||3.03|
|American Funds Trgt Date Rtrmt 2010||-31.12||NA||0.77||61.01||30.56||7.52|
|Barclays Global Investors LP 2010||-21.49||-2.73||0.85||39.06||52.49||7.39|
|Fidelity Adviser Freedom 2010||-28.61||-5.18||0.92||48.48||34.33||14.7|
|Fidelity Freedom 2010||-27.61||-4.6||0.65||47.01||35.67||14.98|
|Hartford Target Retirement 2010||-30.33||-6.34||1.00||54.97||36.19||6.15|
|JHancock2 Lifecycle 2010||-33.00||N/A||1.38||54.92||33.33||8.99|
|JPMorgan SmartRetirement 2010||-25.32||N/A||1.06||43.28||47.34||7.59|
|MassMutual Select Destin Retire 2010||-28.49||-6.6||1.19||53.79||34.53||11.25|
|MFS Lifetime 2010||-15.07||-0.35||1.01||28.54||53.30||16.22|
|Oppenheimer Transition 2010||-41.71||N/A||1.5||65.21||30.31||4.5|
|Principal LifeTime 2010||-33.13||-7.25||0.77||54.29||45.24||-5.27|
|Putnam Retirement Ready 2010||-25.60||-6.17||0.99||25.74||56.84||15.69|
|Russell LifePoints 2010 Strategy||-23.97||-3.5||1.2||34.8||43.62||18.14|
|Schwab Target 2010||-28.36||-4.43||0.92||54.15||31.04||13.33|
|State Farm LifePath 2010 Legacy||-21.80||-3.12||1.27||40.92||50.51||7.57|
|T. Rowe Price Retirement. 2010||-29.57||-4.73||0.61||57.42||35.87||5|
|TIAA-CREF Lifecycle 2010 Retirement||-27.01||-4.32||0.62||53.5||42.22||3.02|
|Vanguard Target Retirement 2010||-24.44||N/A||0.20||53.33||45.07||0.94|
|Vantage Milestone 2010||-20.60||-2.13||0.88||37.17||52.17||10.58|
|Wells Fargo Advantage DJ Target 2010||-16.63||-1.26||1.18||31.53||61.09||6.48|
* Three-year returns are annualized.
Source: ©Morningstar, Inc. (Data through 11/14/2008.) Morningstar makes every effort to ensure accuracy of this data, but cannot guarantee completeness and accuracy.
Longtime financial journalist Barbara Mlotek Whelehan earned a certificate of specialization in financial planning. If you have a comment or suggestion about this column, write to Boomer Bucks.