"2008 was a wake-up call," Surz says. The dramatic losses in stocks that year are a powerful reminder that as retirement approaches, target-date funds should focus on safety. But most life-cycle funds don't sufficiently wind down equity risk as the target date approaches, he warns. As a result, most target-date fund investors within a decade of retirement may be courting trouble.
Surz follows his own philosophy in the SMART Funds, which he runs. The SMART Funds 2010 portfolio, for instance, was recently allocated almost completely in cash and inflation-indexed Treasuries. "When you're nearing retirement, presumably you've done a good job of building up assets," he says. "You're going to start relying on those assets and so you should be fairly protective of those balances."
The reality is that many target-date funds are being run with investment horizons that extend well beyond the target date. As a recent advisory from the U.S. Labor Department and Securities Exchange Commission noted, "Some target-date funds may not reach their most conservative investment mix until 20 or 30 years after the target date."
A review of target-date funds using Morningstar Principia software confirms the government's warning. Of the 49 funds with target dates no later than 2010, 47 recently had equity allocations that ranged from about 2 percent up to 64 percent of assets, with just two reporting no stock holdings. More than three-quarters of these target-date funds had equity allocations above 30 percent, in some cases well above 50 percent. By Surz's reasoning, all 49 funds should have equity allocations at or near zero.
In principle, Surz doesn't disagree. He also emphasizes that his view on target-date funds shouldn't be confused with advice on how a new retiree should invest for the years ahead. Depending on the investor's age, risk tolerance, net worth and other factors, some level of equity allocation may be appropriate. But that's a separate question from the asset allocation for a TDF nearing its target date, he says.
These products should be shepherding investors through the asset accumulating phase of their lives, followed by a gradual lowering of the equity allocation during the risk zone. When the target date is reached, the TDF should be prepared to turn over the assets to a new retiree. At that point, the investor can and should rethink his asset allocation strategy for the post-employment period ahead, says Surz.
New disclosure rules proposed
Is the issue simply one of proper labeling and letting investors make a decision? The SEC is leaning in that direction. The federal securities regulator recently proposed new rules that, if adopted, would require that target-date funds "disclose the fund's asset allocation at the target date immediately adjacent to the first use of the fund's name in marketing materials." By contrast, asset allocation strategy is unclear based on current target-date fund names, although one could always read through the prospectus for additional insight.
Regardless of whether the rule passes, protect yourself by understanding your target-date fund's strategy. Are you comfortable with the risk level in the portfolio? Does management clearly state its intentions for managing risk? If not, it may be time to sell and transfer the money to products that satisfy your risk tolerance and investment strategy.
Even if you believe that holding equity risk after retirement is appropriate, you should be confident that your lifecycle fund is the best product for that goal. But be aware that some target-date funds are designed for accumulating assets over the decades ahead of retirement. Expecting them to also function as post-retirement investment strategies may be asking for too much in some cases. And since you won't have a second chance to build a lifetime worth of savings, it may be best to err on the side of caution.
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