How We Learned to Love Target-Date Funds in a Decade

NEW YORK (TheStreet) -- When stocks plunged in 2008, many investors felt their faith in target-date funds sorely tested, suffering deep losses in investments they'd considered safe. But doubts appear to have dissolved, as TDFs show growing appeal, especially in 401(k)s.

TDFs use a heavy allocation to stocks when an investor is young, gradually moving to a more conservative mix of stocks and bonds near and after retirement. The automatic shift eliminates one of the biggest investing hassles. The investor selects a fund with a target date matching the expected retirement year, and the fund company does the rest.

Vanguard says 55% of participants in its 401(k)s now have target-date funds, up from 2% in 2004 and 28% in 2008. About 34% of all contributions are now directed toward TDFs, compared with almost nothing in 2004 and 13% in 2008.

How come?

One reason: after the smoke cleared in 2008, investors presumably noticed their TDFs, despite big losses, actually did better than the markets as a whole. Previously, many investors had not understood clearly that TDFs may keep a lot of the individual's holdings in stocks even after the retirement date begins, to ensure enough growth to offset inflation. Along with the stock allocation comes a risk of loss when the market dives.

Another important factor is the growing adoption of a TDF option by employers. Last year, 86% of Vanguard-managed plans offered at least one TDF, up from 13% in 2004 and 68% in 2008. In recent years, more and more plans have designated TDFs as the automatic or "default" investment choice for new participants who do not specify another option. Earlier, plans typically used a low-return money market fund as the default.

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