As the fastest-growing products in defined-contribution plans,
are marketed as set-it-and-forget-it, one-step investment
solutions for retirement plans.
They automatically increase bond-exposure-relative stocks the
closer that they get to the "target year" in their name,
theoretically reducing risk and preserving principal as
get closer to retirement.
In 2013, more than 20 years since target-date funds debuted,
inflow into the funds accounted for nearly a third of new assets
into management firms. The total amount invested in target-date
funds topped $690 billion as of June 30, up 6% from a year
earlier, according to Morningstar. Second-quarter inflow totaled
$15 billion, 25% higher than the funds' historical average
quarterly inflow of $12 billion.
Falling management fees no doubt have helped boost their
popularity. Average industry expense ratios dropped from 1.04% in
2008 to 0.84% in 2013, according to Morningstar, as providers
increased use of indexes over actively managed portfolios within
the target-date wrapper.
The three largest players -- Fidelity, Vanguard and T. Rowe
Price -- accounted for three-quarters of the target-date
In the past five years, target-date funds have performed just
as well as if not better than other asset-class benchmarks.
Morningstar's Target Date 2026-30 fund category returned an
average annual 11.9% and 10.9% in the past three and five years
as of Aug. 14.
They're a middle ground between stocks and bonds. SPDR S&P
) returned 20.8% and 16.5% a year in the equivalent periods,
whileVanguard Total Bond Market ETF (
) earned 2.6% and 4.4% yearly.
The bond portions of target-date funds may become more
volatile than they were in the past if current ultralow interest
rates rise back to normal. Investing in bonds might have been a
no-brainer the past 30 years as interest rates trended downward,
giving way to rising bond prices.
Falling bond prices could lead to losses in the bond portion
of the portfolios -- at least in the short run -- just when
need to preserve principal the most.
The Federal Reserve, which has kept interest rates
artificially low since 2008 to stimulate the economy, is expected
to let rates rise in the first quarter of 2015. The benchmark
10-year Treasury yield, at 2.34% as of Aug. 15, is sharply below
its historic average of 4.63%.
"If interest rates do start to move significantly higher, bond
investors could be in for a rough ride," Ethan Anderson, senior
portfolio manager at Rehmann Financial in Grand Rapids, Mich.,
with $1.5 billion in assets under management, said in an
The more exposure that funds have to long-dated bonds, the
more sensitive they'll be to interest-rate changes, as measured
by duration. IShares 7-10Year Treasury Bond ETF (
), with an average effective duration of 7.56, fell 6.1% in 2013
when benchmark 10-year Treasury yields rose 1.18% to end the year
Yields on 30-year Treasuries climbed 0.92% to 3.96% the same
year. That gave way to a 19.9% nose dive inVanguard Extended
Duration Treasury ETF (
), a portfolio of 20- and 30-year government bonds. Highly
sensitive to rate changes, it has an effective duration of
Investors can mitigate the bond risk by opting for target-date
funds that hold more short-term bonds.
IShares Target Date 2020ETF (
), the largest target-date ETF with $57 million under management,
has put 57% of assets in stocks and 39% in bonds. It returned
14.61% last year and is up 4.3% so far this year.
The bond portion consists of iSharesShort Treasury Bond (SHV),
which has an effective duration of 0.46 and was unchanged last
year, and iShares Core U.S.Aggregate Bond (AGG), which has an
effective duration of 5.25 and lost 2.0% in 2013. SHV is up 0.2%
this year, while AGG has gained 4.66%.