Memo to SEC, DOL: Regulate target date funds — now

With some $2.4 trillion sucked out of retirement accounts since early last year, lawmakers have predictably made the 401(k) system a flaming target for change, and, also predictably, their ideas are way off base — except for one
Sen. Herb Kohl, D-Wis., who chairs the Special Committee on Aging, has called on both the Department of Labor and the Securities and Exchange Commission to begin regulating target date funds for the first time.
The notion initially smacks a bit like Big Brother — especially to the asset managers who design and run these set-it-and-forget-it funds — but not if the industry’s self-interest takes a back seat to individual investors’ best interests.
The managers surely don’t want to be told by the federal government exactly how to sell and administer a product that’s expected to haul in hundreds of billions of dollars in new assets over the next few years.
However, investors in target date funds saw their nest eggs evaporate over the last year as the equity markets kissed 15-year lows and were about as dysfunctional as a Lohan family reunion. And older investors in target date funds have been affected most, especially those who had planned — or at least hoped — to retire in the near future.
Target date fund assets totaled $152.8 billion in 2008, down from $177.7 billion in 2007.
In theory, target date funds are supposed to get more conservative over time and dial down on the exposure to equities as investors approach their estimated retirement dates, a time when they need a steady income the most and can least tolerate investment risk.
Yet, if we’ve learned anything in the last year about these relatively new funds, it’s that many target dates expose older investors to substantially more risk than anyone could have imagined.
Every fund takes its own approach, or “glide path,” as it winds down, which is why there was such a dramatic range in the performance of funds last year.
Consider these numbers: the best performing target date fund for people who are either already retired or are approaching retirement has been the DWS Target 2010 fund from DWS Investments in New York, according to data tracked by Morningstar Inc. of Chicago. This fund lost only 6.22% for the one-year period ending March 26.
On the other end of the spectrum is Oppenheimer Transition 2010 from New York-based OppenheimerFunds Inc., which posted a 40.16% loss during the same period, making it the worst performing retirement-stage target date fund tracked by Morningstar.
For any older investor to lose 40% of his or her assets in a single year when they’re that close to retirement — and in a fund they probably thought was invested somewhat conservatively — is obscene.
Not only might these individuals be forced to delay their retirements, but it could take them another five to 10 years just to get back to where they were just one year ago. And by that point, they could be in their mid-70s.
And that’s exactly why Mr. Kohl has called on the DOL and the SEC to take a closer look at target date funds.
Not only is the potential for loss greater than most anticipated, but many companies are now also placing their employees into their 401(k) plans’ target date funds when they pull the trigger on an automatic enrollment program. (Target date funds, not all that long ago, were “blessed” by the DOL as qualified default investment options. This was, of course, when markets were humming along at all-time highs.)
If 401(k) participants are being steered into government-approved funds, then the government has a responsibility to re-evaluate its thinking after many of these target date funds have failed their first true stress test.
The best and simplest step might be for the DOL and SEC to place limits on the amount of an investor’s assets that can be held in equity portfolios at their actual retirement date.
Some have suggested that any equity exposure might be too much, but that’s a bit extreme.
Investors should have choices, and some will want the equity component in their funds to add some potential juice to their performance.
Yet, regulators may want to consider drawing a line for fund companies that might be inclined to invest the majority of participants’ assets in equities after they retire. Or, at the very least, perhaps it should be required that the name of a target date fund clearly state whether it invests conservatively, moderately or aggressively.
Target date funds are supposed to be for investors who aren’t inclined to choose every single fund that they invest their retirement assets in, and then re-balance and reallocate every year until they stop working. So in this case, a limit on equities is less a form of Big Brother than it is simply an emergency brake that could protect investors from a worst-case scenario.

Mark Bruno is a reporter at InvestmentNews. He is the author of the book “Save Now or Die Trying: Achieving Long-Term Wealth in Your 20s and 30s” (John Wiley & Sons Inc., 2007).