Target-date funds miss the mark
The set-it-and-forget-it retirement fund option suddenly gave investors a wake-up call.
The Callan Target Date Index posted a return of minus 0.86 percent for 2015, its first annual loss since 2008, the investment consultant reported Tuesday.
These funds get their name from the year in which an investor anticipates retiring. The assets gradually move from riskier investments — which come with the potential for higher returns — to more conservative options, such as bonds and cash, as it nears the targeted retirement date.
They have become the go-to option for many workers. They also increasingly are the default option for many 401(k) plans when an enrollee does not specify investment choices.
Read More Check under the hood before you pick a target-date fund
Longer-dated funds with the greatest equity exposure — geared toward younger workers — were hit the hardest.
That means an average participant in their 20s in the worst performing 2055 target date fund, which is considered a long-dated fund, notched about an $800 loss in their account balance last year, said Lori Lucas, head of Callan's Defined Contribution practice.
The negative performance came after several large target date fund managers reported increasing their allocation to equities over the past several years, Lucas said.
"After the carnage of 2008, when the median target date fund lost 26.41 percent, target date fund managers generally decreased their allocations to equities and improved their overall diversification," Lucas explained.
But the recent move toward greater diversification, particularly in small caps and stocks outside the U.S., is what ultimately hurt the funds overall last year despite a positive fourth-quarter performance.
Target date funds returned 3.01 percent in the final quarter of 2015, as measured by the Callan Target Date Index, as the S&P 500 rose 7.04 percent and bonds fell 0.57 percent, as measured by the Barclays U.S. Aggregate Index.
Assets in target-date funds stood at $763 billion at the end of 2015, according to research firm Morningstar. Last year investors pumped over $70 billion into these funds.
The Callan Target Date Index is an equally weighted composite of 44 target date fund series, including both mutual funds and collective trusts.