Target-Date Funds Might Overshoot Equity Target

Defined contribution participants nearing retirement may be shocked at the asset allocation to equities in their target-date funds, says a new research paper by Watson Wyatt.

In a news release about its research, Watson Wyatt said some target-date funds might retain more risk by allocating more to equities than might be optimal. For example, some funds for employees expecting to retire in 2010 still have almost 70% of assets in equities, according to recent Morningstar Direct research.

The company said its analysis of target-date funds has shown considerable variability in asset allocations. For instance, in 2006, allocations to equities for employees 10 years from retirement varied from 80% to 40% among target-date funds. Equity allocations for employees on their retirement day ranged from 65% to 20%.

“The lack of consistent philosophies in this area means that products with very similar names can have very different compositions,” said Robyn Credico, National Director of Watson Wyatt’s defined contribution practice. “As more employers begin to automatically enroll employees who do not choose 401(k) investments in target-date funds, understanding the amount of return received for the risk grows in importance. If the funds are not appropriately matched with employees’ needs, employers could see many workers delay their retirements.”

Watson Wyatt advises those creating or selecting target-date funds to do the following:

  • Analyze the participants in the plan and their potential retirement resources. This information should be used in reviewing plan design and in selecting the appropriate investments offered and communications given to participants.
  • Examine how to use risk-reducing assets, such as long-duration bonds and Treasury Inflation-Protected Securities, to diversify the portfolio and to hedge interest rate risks when participants employ life annuities for their retirement distributions. Look at various types of bonds to determine which might more effectively reduce risk.
  • Determine how to maximize rewards through diverse investments.

More information on the report can be found at