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New and Young Investors Gravitate to Target Date Funds

Author: Barry Randall
Last Update: 12:37 PM ET November 19 2013

12:30 PM New York – Target-date funds have become an increasingly popular single-fund investing vehicle for retirement planning. The dramatic increase in target-fund assets has been fueled in part by tacit regulatory approval. However, it is not clear that the strategies employed by these funds will generate enough assets to satisfy retirement needs.

Target-date funds, in their new incarnation, have become the default choice for many young investors.

Investors, who are uncertain how to allocate their 401 (k) assets, are parking retirement assets in target-date funds and postpone making investment decisions for the long term.

Since the Pension Reform act of 2006, retirement funds or popularly known as target-date fund have seen an explosion in assets.

The first retirement fund with a specific target date was formulated about 20 years ago. Since then, assets have continued to balloon in these funds and now total $400 billion – five times what they were in 2005.

At least 33 mutual funds companies are managing assets under target-date funds strategies, according to a list compiled by research staff at Ticker.

By one estimate, single-fund investments are likely to attract nearly half of all 401 (k) plan and other defined contributions assets by the end of this decade. In addition, most retirement experts see no sign that the asset inflow is slowing.

But while the assets grow, plan advisors and asset managers continue to debate what strategies are best for reaching the asset goal at the so-called retirement target date. A level of assets sufficient to provide income to the retiree for the balance of his life.

That debate was the central focus of a number of presentations at the Center for Due Diligence’s 2013 Advisor Conference, which was held in October in San Antonio, Texas.

Phil Chiricotti, the organization’s president, said the conference attracted more than 1,200 retirement advisors and industry professionals.

The government-approved, default retirement option for 401 (k) plan has fueled the latest surge in these funds, but whether the funds will prove beneficial is still unknown. The funds have not been around long enough to judge their relative performance.

Age Based Investing

The basic assumption underlying target-date funds is straight forward: that age is the single most important factor in selecting an investment strategy. Since younger investors have more time to grow their assets, they can assume more risk; but, older investors need to protect the assets they have and focus on generating a steady flow of income.

The concept of a target-date funds is a slight variation of hybrid funds that have been around for more than four decades. By shifting a portfolio’s allocation between bonds and stocks, based on the current and expected state of the economy, a portfolio can generate steady returns with less volatility then investing in only one asset class.

However, Joe Lee, the head of Black Rock Advisor-sold Distribution, said that most retirement plan sponsors are confused and fail to consider a participant’s age and risk factors together when making allocation recommendations.

How Target-date Funds Have Evolved?

Thirty years ago investors were comfortable simply dividing assets between U.S. stocks and bonds. Then two decades ago, style boxes became the fashion and investors divided their assets among funds based on market caps and investment type but still domestic U.S. focused.

But the style-box allocation had its limits because it was based on U.S. stocks and bonds and did not allow for other assets such as commodities, real estate, and international investments.

As the rest of the world powered ahead of the U.S., investors sought to further diversify their assets with international stocks and bonds. And with the emergence of commodity super cycle fifteen years ago, investors started adding commodities to their investment strategy.

With the expanding opportunities of alternative investment, individual investors are faced with increasingly complex allocation decisions. Since most individuals are not good at making timing decisions, they are loath to take on the multi-dimensional, investment decisions they now confront.
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Sources: Data collected by 123jump.com and Ticker.com from company press releases, filings and corporate websites. Market data: BATS Exchange. Inc