Target-date funds shoot at moving, variable targets

Looking at target-

date funds is a bit like trying to decide on a rental car.

You go to one agency, and find certain models from GM or Ford or Toyota, with certain models considered midsize.

The next rental company considers those same cars as "standard," while the third place will put certain cars in both the standard and full-size group.

You get a full-size car from the fourth place, and it's the same model that the first place tagged as midsize, the second as standard and the third (and fourth) as full-size.

Lots of vehicles, similar-but-different, available at varying terms, descriptions and conditions.

Key savings vehicle

The target-date fund, according to Sen. Herb Kohl, D-Wis., during a recent congressional hearing, is "on track to become the No. 1 savings vehicle in America."

But if you look at the firms offering target-date funds — portfolios that adjust automatically to become more conservative as the investor nears, and then enters, retirement — you quickly see that the rules are as confusing as they are at the rental-car counter.

The average consumer may want a full-sized retirement but won't know until it's too late that his fund is likely to deliver only the economy model.

What investors learned at the Special Senate Committee on Aging hearing that looked at target-date funds as part of its efforts to strengthen the nation's retirement-savings system, is that investors won't get any relief soon.

The committee's primary concern was the right one, the lack of transparency and consistency in how these funds are designed.

Target-date funds typically have a "glide path" designed to gently bring the investor toward retirement age and beyond.

But take a look at two 2010 funds with wildly different portfolios, and see if you can tell which one takes a stock position more than 2.5 times bigger than the other.

Return over time

Fund A "is managed to a specific retirement year and seeks to achieve the highest total return over time, consistent with its asset mix.

As the retirement date gets closer, and continuing for 15 years beyond the date ... investment professionals gradually adjust the strategy to a more conservative investment mix. ...

So as you move into retirement, your strategy becomes more focused on protecting principal and generating income."

Fund B "seeks capital appreciation and current income consistent with a decreasing emphasis on capital appreciation and an increasing emphasis on current income as it approaches its target date."

That's two different ways to say "as you age, we get more conservative."

But, as it turns out, Fund A, Alliance Bernstein 2010 Retirement Strategy, had nearly 72 percent of its holdings in stocks last year, two years away from the "move into retirement."

Fund B — Putnam Retirement Ready 2010 — had about 26 percent of its assets in stocks, so its emphasis on moving to bonds was huge long before the investor ever reached retirement age.

Different approaches

Therein lies the problem. An investor sees the target date, hears the strategy and winds up with funds that have widely different approaches.

Moreover, these funds are frequently default choices, where it's not the investor but the employer who makes the call.

If the boss picked Alliance Bernstein for the 401(k) and auto-enrolled employees nearing retirement, they would have seen their contributions lose 33 percent last year; had they picked Putnam, the loss would have been about 26 percent.

That's a big difference for someone with so little time before retirement to recoup the loss.

Indeed, the Committee on Aging found the date in the name of target-date funds frequently is inconsistent with their design, making them difficult for investors to evaluate and compare; the asset-allocation plan — the glide path — varies greatly among funds with the same dates, its report said.

That's not news. The Securities and Exchange Commission is looking at ways to make names reflect holdings, but that's going to be hard because the industry can't agree on a model of what a target-date fund looks like now.

No easy fix

The possible fixes are not easy and simple. Get five fund executives together to discuss the right way to do something and you'll have 10 different opinions, each tailored to what its supporters actually do best.

Coming up with other language and naming conventions means developing definitions that add more jargon to fund paperwork. The industry needs that the way a moose needs a hat rack.

Asking investors to then sort it out in the prospectus doesn't work, either, because the default investors aren't looking at documents.

While the industry and regulators are test-driving their solutions, the moral of the story is to look under the hood and figure out just what is powering your target-date fund.

Without it, all you know is that you have a popular investment vehicle, not an ideal one.

Chuck Jaffe is a senior columnist

at MarketWatch.

He can be reached

at cjaffe@marketwatch.com

or Box 70, Cohasset, MA 02025-0070.