Often billed as the fund and brokerage industry's quick fix for retirement planning, so-called target-date funds took an unexpected turn for the worse in 2011, according to new data.
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The funds, which have become an integral part of many Americans' 401(k) plans, are designed to protect investors by decreasing their exposure to stocks and increasing their bond holdings as people get closer to retirement, or their "target" year. But the average fund with about four years until its target date fell 0.4% in 2011, according to Morningstar (MORN) Inc., a fund-research firm. That trails the Standard & Poor's 500-stock index, which gained 2%, including dividends, and is well below the Barclays Capital Aggregate Bond Index, which rose nearly 8% for the year.
The results may revive a debate over whether the funds expose investors close to retirement to too much stock-market risk. "We had a real 'stress test' in the first nine months of 2011, and the industry failed," says Ron Surz, a retirement-plan consultant and president of Target Date Solutions. He adds that the returns would have been much worse, but strong gains in the fourth quarter "bailed the industry out."
The funds have become a popular option for company 401(k) plans, with $368 billion in assets in 2011, more than double the amount they held in 2008.
As part of the Pension Protection Act of 2006, target-date funds were made one of a few permissible "default options" for retirement plans with an automatic enrollment feature, meaning some employees are automatically enrolled in the funds. But far from protecting investors, many target funds performed worse than other funds during the market crash of 2008.
Since that downturn, the funds have generally done well -- until last year.
Experts say target funds' broad array of holdings actually hurt last year, as many investors fled to blue chip stocks and long-term government bonds. "They're intended to be diversified, and that should be an advantage over the long term," says Josh Charlson, a fund analyst with Morningstar. "But it's not always going to work so well, particularly when there's a flight to quality in the market."
Despite widespread criticism from regulators and lawmakers after 2008, the average fund nearing retirement today has 40% of its assets in stocks, down only three percentage points from 2008, according to Lipper.
And while retirement experts say target-date funds are still well-suited for investors without the knowledge or desire to select their own investments, many financial advisers recommend that more independent-minded investors build their own retirement portfolios.
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