Target Funds Tweak Their Game

Fund Watch

Target-Date Funds Creating New Risks for Older Investors

Fund providers are adjusting glide paths to overcome new retirement saving challenges


Target-date funds are devising new strategies designed to help investors achieve a secure retirement. But along the way, they're introducing new risks for older investors.

See Also: Best Target-Date Funds for Retirement Savers

These funds, a staple of 401(k) plans, hold stocks, bonds, cash and other investments. Following a pre-set "glide path," the asset mix gradually becomes more conservative as the "target date," which corresponds to the investor's retirement date, approaches.

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Challenges currently facing retirement savers, including low bond yields, the expectation of rising interest rates and longer life expectancies, are prompting many target-date fund managers to shake up their investment mix—particularly in portions of the glide path just before and after the target date. Recent adjustments made by some major target-date fund providers include boosting stock allocations for preretirees; shifting away from traditional, high-quality bond holdings in favor of high-yield bonds and alternative, hedge-fund-like strategies; and giving fund managers more leeway to deviate from the predetermined glide path to take advantage of market opportunities.


Fund companies say their new strategies help achieve a better balance between market risk and longevity risk—the risk that investors will outlive their money. But the changes also raise concerns for older investors. Higher doses of stocks and lower-quality bonds can make target-date funds more volatile. And hedge-fund-like strategies often carry higher fees, putting upward pressure on target funds' costs.

Investors need to keep close tabs on what's happening inside these funds, especially since they're built to be 100% of your portfolio, says Jeff Holt, associate director of multiasset strategies at investment research firm Morningstar. Although it's natural for these funds to evolve over time, "investors should be leery of changes that reflect flip-flopping" in terms of investment philosophy, Holt says.

Target-date fund assets have been soaring ever since a 2006 law gave 401(k) plans a green light to use these funds as a default investment. Investors poured a record $69 billion of net new money into the funds last year, bringing total assets to more than $763 billion.

The answers to the following questions will help you understand the potential risks and rewards of a target-date fund.


What is the fund's goal? The target-date fund industry has long been divided into two camps. The "to retirement" funds aim only to bring the investor up to the retirement date, making no further asset-allocation adjustments in the retirement years. The "through retirement" funds, which aim to balance market and longevity risks throughout the investor's life, continue to dial down the portfolio risk throughout retirement.

The Dimensional Target Date Retirement Income funds (TDIFX), launched last year, are throwing a new objective into the mix: They aim to boost the investor's certainty about how much income a nest egg can sustain in retirement. To do that, the funds shift heavily into inflation-protected bonds during the 20 years before the retirement date. At the retirement date, they devote 75% of assets to Treasury inflation-protected securities. The hefty TIPS allocation helps protect investors' "real" (after-inflation) purchasing power in retirement, says Massi De Santis, vice-president at Dimensional.

For investors who are behind on retirement saving, a TIPS-heavy portfolio may not offer enough growth to make their money last a lifetime. But Dimensional rejects the idea that target-date funds should maintain a larger stock allocation to reduce the risk that investors will run out of money. Funds shouldn't solve the problem of investors not saving enough by taking more risk into retirement, De Santis says.

Some more established target-date funds are taking the opposite stance. The Fidelity Freedom funds, for example, increased stock allocations across most of the glide path in late 2013. In addition to longer life expectancy, the move was based on Fidelity's higher return expectations for stocks and 401(k) investors' apparent tolerance for risk, says Mathew Jensen, director of target-date strategies at Fidelity. "We saw individuals being very consistent and steady in their target-date fund investments, regardless of the fluctuation up and down in the market," he says.

See Also: Pick the Best Target-Date Fund For You


What's under the hood? In recent years, many target-date funds have been trimming plain-vanilla bond holdings in favor of foreign developed and emerging-markets bonds, high-yield debt, and "unconstrained" bond strategies—which can invest anywhere in the bond market.

In the John Hancock Retirement Living Through 2015 fund (JLBAX), whose investors are just entering retirement, about 30% of the fixed-income allocation is in bonds rated BB or lower, according to Morningstar. Although high-yield bonds have been whipsawed lately, the allocation has "paid off handsomely" over the longer term because the fund added to the position in 2009, catching a major post-financial-crisis rebound, says Marcelle Daher, the fund's co-portfolio manager.

Examining your target-date fund's underlying fund holdings can give you another view of the potential risks. The Dimensional 2020 Target Date Retirement Income fund (DRIRX), whose investors are on the brink of retirement, devotes nearly 30% of assets to DFA LTIP fund—a long-term TIPS fund that is highly sensitive to interest-rate changes and lost 26% in 2013. "I wonder if investors are prepared to see those types of losses in a bond portfolio while they're in retirement," Holt says. Dimensional says it doesn't expect its target-date funds to be more volatile than others in the industry.

How steep is the slope? A target-date fund's glide path "slope" is the rate of change in the stock allocation over time. Some target-date fund families have made their slopes a bit steeper lately, Holt says, by boosting stock allocations in the years leading up to retirement while holding them steady at the retirement date.


But a steeper slope can be riskier for investors. A fund manager who is trying to stay in line with a steep glide path may be forced to rapidly sell stocks in the years leading up to the target date, even if the market is slumping. And the fund may have difficulty recovering from those losses, since it will have relatively little exposure to any subsequent stock-market rebound.

To see an illustration of your fund's glide path, along with details on the underlying holdings, enter the fund name or ticker in the quote box at and click "portfolio."