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Target-Date Funds Tank

While most funds have suffered lately, the downturn has been particularly excruciating for investors in target-date funds.

During the third quarter, the average target fund lost 10%, compared with a loss of 8.4% for the S&P 500, according Ibbotson Associates, a Chicago research firm. "Many investors were shocked by the unexpected losses in target funds," says Tom Idzorek, Ibbotson's chief investment officer.

Designed for retirement savers, the target-date funds hold broad portfolios of stocks and bonds. Because the big bond holdings should cushion results, investors expect the target-date funds to be relatively stable in downturns. But in their efforts to diversify, many target funds hold positions in foreign stocks and commodities. During the third quarter, emerging market stocks fell 26.9%, while commodities dropped 27.7%, according to Ibbotson. That dragged down average fund returns.

The decline in target-date funds is significant because they have become enormously popular. Participants in 401(k) plans are currently putting half their new contributions into target funds, which have $277 billion in assets. Cerulli Associates, a financial consultant in Boston, estimates that the target funds will have $1.1 trillion in assets by 2012. If the target-date funds fail to deliver decent returns, the success of the 401(k) program could be in doubt.

The target funds are offered for a series of retirement dates, such as 2020 and 2025. A saver can pick a fund with a target date near his scheduled retirement. As the saver approaches retirement, the fund automatically increases its fixed-income allocation. That way the portfolio becomes more conservative and is less likely to suffer losses that a retiree could ill afford.

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