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Fund Spy

The Funds That Ate Your Retirement Really Didn't

Funds for near-retirees bounce back after the crash.

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Target-date funds, particularly those designed for investors retiring around 2010, received a lot of attention in the wake of equities' October 2007-March 2009 bear market--but for many of the wrong reasons. Investors assumed these broadly diversified investment vehicles would hold up well in a downturn. But target-date 2010 funds, for example, lost 37% in the bear market. That's a lot less than most equity indexes, but it was a steep drop for investors very close to or just entering retirement.

There were two major issues that caused 2010 funds to suffer so badly. First, many of the nonequity securities they own dropped nearly as far as stocks (even further in some cases), including high-yield bonds, convertible debt, and even some bonds rated as investment-grade. In addition, the funds tend to own healthy stakes in companies based outside the United States, which generally performed even worse than U.S.-based firms (which, as represented by the Wilshire 5000 Index, declined 55% in the bear market). For example, the MSCI EAFE Index dropped 59% and the MSCI Emerging Markets Index lost 60%. True, many target-date funds ratchet down their foreign weightings before they reach their target date, but such exposure still dragged down the funds.

Second, many target-date funds were launched during equities' rally from late 2002 to late 2007. (Indeed, 19 of the 30 target-date 2010 funds were rolled out during this period.) This surge may have made equities more attractive to managers of target-date funds when they built models (often predicated on historical asset class returns) as they were designing or tweaking the funds' glide paths. (A glide path illustrates how a target-date fund's asset allocation is scheduled to change over time.) That confidence in equities in turn possibly made the managers focus more on longevity risk--the risk that investors in the funds would run out of money in retirement. As a result, the typical 2010 fund had an equity weighting of 54% at the end of September 2007, just days before equities' peak. (That weighting has since declined to 47%.)

Greg Carlson does not own (actual or beneficial) shares in any of the securities mentioned above. Find out about Morningstar’s editorial policies.