The investment community is hopeful that with a little tweaking, target-date funds could be the ideal solution for getting apathetic investors into an age-appropriate asset allocation.

Still in their early, formative years, target-date funds are not perfect and will probably never replace individually customized portfolio management, but when used as the default option in automatically enrolled 401(k) plans and combined with automatic escalation, the funds can get hands-off investors channeled into a pretty good product.

"Target-date funds are one of the best innovations this industry has seen," said Edward Bernard, vice chairman of T. Rowe Price Group, at the Investment Company Institute's General Membership Meeting in Washington.

"This downturn certainly brought trade-offs, but we don't want to overreact to that," he said. The wide variance in target-date funds still needs to be addressed, he said, particularly with regard to the glide path of funds about to mature.

Certainly, that could be the outcome of a June 18 joint hearing on target-date funds that the Department of Labor and the Securities and Exchange Commission announced last week.

"Great minds don't always agree on a glide path," said Barbara Fallon-Walsh, a principal at Vanguard, noting the wide range of equity exposure in 2010 funds.

Robert Reynolds, the president and chief executive of Putnam Investments, said "no one is arguing that funds with 30 to 40 years left need a healthy equity exposure, but some of these 2010 funds go from a 20% to 70% equity exposure. That's a pretty wide door to drive through."

The funds are designed to gradually shift investors into a more conservative asset allocation over time. While some managers think a portfolio should contain only bonds and fixed income at the time of retirement, others argue that investors should maintain an exposure to equities well into retirement to make sure they don't outlive savings.

The critical flaw in these aggressive glide paths and Monte Carlo simulations is that they depend on markets' behaving in an orderly, historically predictable manner. The 2008 recession threw all those models out the window.

The average loss of 31 different 2010 target-date funds was almost 25% in 2008, with losses ranging from 3.6% to 41%, according to the SEC.

Mary Schapiro, the SEC's chairman, said the agency is looking at the "vast disparity in returns that target-date funds produced last year, and how the use of 'target date' in a fund's name potentially may mislead or confuse investors." A recent survey found some investors thought it guaranteed a date when they could comfortably retire.

Although he would like to see automatic enrollment become mandatory, Larry Goldbrum, general counsel of the Spark Institute, said he thinks it would be a mistake to mandate a specific asset allocation for target-date funds. "You can't regulate or legislate investment management," he said. "Target-date funds are still a relatively new investment product and money managers are still fine-tuning them. Investment management should be left to investment professionals."

Reynolds said the fund industry should step up and figure out the answer on its own. "Only 17% of Americans think they have enough money for retirement," he said. "We need to step into this void and fix our weaknesses. The SEC for years has dictated how much is invested in what. I predict we'll see the same thing in age-based funds. As industry people, we should not sit back and wait for the answer to come out of Washington."

Many firms are developing complicated enhancements to target-date funds that provide various kinds of income guarantees, but most passive investors don't care how these product work; they just want to have enough money when they retire.

Getting young and low-paid workers to invest can be difficult, but employers have had tremendous success lately by automatically enrolling new workers into the company 401(k) plan. Workers have the ability to opt out of the plan, but only 14% of automatically enrolled workers chose to do so, according to research by Vanguard. Auto enrollment has had an 86% average participation rate, compared with a 45% average participation rate among voluntarily enrolled 401(k) plans.

"More than 50% of our plan sponsors utilize automatic enrollment, and 90% of those that do use target-date as a default," said Scott David, president of workplace investing at Fidelity Investments.

He said target-date funds are becoming the investment option of choice for passive investors. Fewer than 1% of target-date investors did an exchange in the last year, compared with 8% of self-directed investors.

"People in their 20s and 30s have been handed a great opportunity," Bernard said. "The market hit 'reset.' Younger investors didn't lose much money because they didn't have much money to lose."

Bernard said the primary way most investors are introduced to mutual funds and the stock market is through their company 401(k) plan. Because only a small percentage of investors are likely to opt out of an automatically enrolled plan, this puts inertia on the investor's side, he said.

"Investors have been much more calm and balanced than what people are speculating and what you see in the headlines," Bernard said. "Never is a long time, and to say people will never recover from this is probably wrong. Participants are calmer than those who are writing about them."

Even during market crises, most passive investors continue to remain passive. In fact, many are so passive they won't take steps to protect their assets or increase their contribution rates.

To get more people saving, mutual fund firms should try to copy the success of automatic enrollment by implementing automatic escalation of contribution rates, Goldbrum said.

Fallon-Walsh said that "unless you automatically increase their asset allocation, investors will stay in whatever you put them in."

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