The Labor Department's (DOL) Employee Benefits Security Administration and the Securities and Exchange Commission (SEC) have issued a guidance bulletin aimed at raising awareness of how target date funds operate and the risks associated with target date investments.

The bulletin examines the significant differences in asset allocation strategies among various target date or life cycle funds, according to a news release accompanying the guidance. The bulletin could help investors and plan participants assess the appropriateness of including target date funds in their retirement portfolios.

The bulletin, Investor Bulletin: Target Date Retirement Plans, notes that target-date funds “are designed to make investing for retirement more convenient by automatically changing your investment mix or asset allocation over time. Asset allocation involves dividing an investment portfolio among different asset categories, such as stocks, bonds, and cash investments. Once you select a target date fund, the managers of the fund make all the decisions about asset allocation.”

Target date retirement fund basics.

“Target date funds, which are often mutual funds, hold a mix of stocks, bonds, and other investments,” the bulletin says. “Over time, the mix gradually shifts according to the fund's investment strategy.”

These funds are designed to be long-term investments for individuals with particular retirement dates in mind, according to the bulletin, which said the fund's name usually refers to its target date. For example, the bulletin states, a fund named “Retirement Fund 2030” would be designed for someone intending to retire in or near the year 2030.

However, the bulletin notes that funds sharing the same target date may have very different investment strategies and risks. The bulletin warns that they do not guarantee a sufficient retirement income at the target date, and that investors can lose money.

Target date funds do not eliminate the need for investors to determine beforehand and afterwards if particular funds fit their financial situation, the bulletin says. Individuals may determine, based on their investment objectives, tolerance for risk, and other assets, that a target date earlier or later than the intended date of retirement may be more appropriate. They may determine that another fund is more appropriate, or that they don't want to invest in a target date fund, the bulletin notes.

“Most target date funds are designed so that the fund's mix of investments will automatically change in a way that is intended to become more conservative as you approach the target date,” the bulletin says. “Typically, the funds shift over time from a mix with a lot of stock investments in the beginning to a mix weighted more toward bonds.”

Careful evaluation urged.

The bulletin urges careful evaluation of target date funds before investing. “The target date may be a useful starting point in selecting a fund, but you should not rely solely on the date when choosing a fund or deciding to remain invested in one,” the bulletin says. “You should consider the fund's asset allocation over the whole life of the fund and at its most conservative investment mix, as well as the fund's risk level, performance, and fees. This information is available in the fund's prospectus.”

The bulletin provides an example that shows a fund holding 60 percent of its investments in stocks at the target date and 40 percent in bonds. In this example, the investment in stocks decreases until 25 years after the target date, when it reaches an investment mix with 30 percent in stocks.

A second example shows a fund holding 25 percent in stocks at the target date, and reaching its final investment mix with 20 percent in stocks 25 years later. This fund also holds cash investments as part of its mix.

“Target date funds also may have different investment results and may charge different fees, even with the same target date,” the bulletin states. “Often a target date fund invests in other mutual funds, and fees may be charged by both the target date fund and the other funds. Keep in mind that a fund with high costs must perform better than a low-cost fund to generate the same returns for you. Even small differences in fees can translate into large differences in returns over time.”

According to the bulletin, consideration should be given to how a target date fund fits with other investments, and overall asset allocation should be carefully examined.

The bulletin includes a list of additional resources on target date funds. For more information go to: http://www.dol.gov/ebsa, click on DOL and SEC Issue Guidelines on Target Date Retirement Funds.

Copyright 2010, The Bureau of National Affairs, Inc.