This post is from GRS staff writer April Dykman.
During the 2008 financial crisis, target date, or life-cycle, funds were hit hard. People who were just a couple years away from retiring held 2010 target date funds that lost 24% of their fund’s assets on average, with a range of 9% loss to a staggering 41%.
Same date, different allocation
According to the Securities and Exchange Commission (SEC), many investors believed that their asset mix would become more conservative as they neared the target date. But what many didn’t know was that the amount of risk could vary widely, even among funds with the same target date. From the Washington Post:
The SEC said that life-cycle funds with the same target date had equity exposures that ranged from 25 percent in stocks to 65 percent. It could be years after the target date is reached before a particular fund’s asset mix switched to a more conservative approach.
Proposed rules to educate investors
To increase investor understanding of how these funds work, last month the SEC proposed new rules for target date funds in a 100-page report and is seeking comments from the public about the proposal. The highlights include the following:
- Marketing materials would have to disclose the asset allocation as a tag line with the fund’s name the first time that name is used. The proposed rule would allow an investment company to list a range of allocation for an asset class, such as “30-35%”.
- Target date firms will have to provide investors with a graphic depiction of asset allocation for the life of the fund (from start date to target date).
- Firms will have to provide investors with a statement explaining that the asset allocation changes over time, stating the year the asset allocation becomes final, and providing the final asset mix.
- Marketing materials will have to advise the investor to consider his or her risk tolerance and financial situation; that it’s possible to lose money; and whether the planned percentage allocations can be changed without a shareholder vote.
Finally, target date funds have been touted as a “set it and forget it” solution to retirement, but being too hands-off with your money has consequences. To address this, the SEC proposed changes to its antifraud guidance to address the age emphasis and “set it and forget it” representations of target date funds. The SEC noted that marketing materials that lead investors to believe an investment is appropriate for them based solely on age (or target age of retirement) or that the plan is easy and doesn’t require monitoring, are misleading.
Are rules tough enough?
While most experts agree that more disclosure is good news for investors, others don’t believe the SEC rules are tough enough. Criticisms include the following:
- The phrase “target date” is misleading and should not be allowed to be used in a fund’s name. The perception is that a 2030 target date fund will provide retirement income for an investor in 2030, and disclaimers are unlikely to change that perception.
- Some experts don’t mind the name, but feel like complicated graphs and confusing fact sheets won’t be easily understood by the average investor. Instead the investor should be told what sort of income is probable given their investments, rate of savings, asset mix, and years until retirement.
- The SEC should do more to explain that target date funds are not guaranteed. Critics point to the fact that the Employee Benefits Security Administration has deemed target date funds as a Qualified Default Investment Alternative (QDIA). In plain English, this means that if an employee neglects to direct their 401K investments, the employer can select a target date fund for them without being held liable. So while the SEC can say the funds aren’t guaranteed, the fact that they are a QDIA will continue to send the wrong signal to many investors.
Target date funds are still a good option for many people, but it’s wise to invest with your eyes open. To help investors better understand target date funds and what to know before investing, the SEC and the Department of Labor issued an Investor Bulletin that explains how the funds work, how to evaluate them, and what to know before investing.
Personally, I’m a fan of target date funds because despite writing about personal finance almost daily, retirement talk makes my eyes glaze over. Nevertheless, I am one of those investors who picked a target date fund without fully understanding much of what the SEC wants to clarify, and now I appreciate how important it is to do some homework when choosing a target date fund.