2012: End of the World? Or the End of Your Target-Date Fund? (Part 2/3)

In the first part of this three-part series we reviewed the fundamentals of target-date funds. What are they? Why do they exist? How are they different from other mutual funds?

Now we’re going to learn a bit about why it’s becoming almost impossible to avoid target-date funds.

The Pension Protection Act (PPA) was signed into law in 2006 and for millions of employees in the United States, this meant that employers could start to implement automatic enrollment in the company’s 401(k) and 403(b) retirement savings programs.

Automatic. We all know what that means.

How did this happen? Well, the PPA introduced guidelines that, if followed, will protect employers from “fiduciary liability” for the outcomes of investments. In plain English: If the “guidelines” are followed, it’s not your company’s fault if your retirement money goes to zero.

One of the guidelines established a very important concept: the QDIA or Qualified Default Investment Alternative. Now the government didn’t pick a few lucky mutual funds and name them as official QDIA products. Instead, QDIAs are described in terms of four general “types” of investments or investment approaches that companies can put their employees’ money into as a default option.

And one of these four “types” is a “product with a mix of investments that takes into account the individual’s age or retirement date.”

Hmmm… that sounds a lot like target-date mutual funds, doesn’t it? Not only are target-date funds a perfect fit for this description, they’re also far and away the most-preferred option for most companies because the other three options are either more work for the company or more expensive (or both!).

And because they’re so popular for 401(k) accounts, target-date funds are also going to be popular for IRAs and almost all other types of retirement savings. They’re easy for brokers to recommend, they’re attractive to self-directed individual investors because they’re marketed as simple one-stop solutions, and there is a lot of competition among investment companies to get your money invested in their target-date products.

So let’s face it, if we’re going to find it hard to avoid target-date funds, what should we do about it? That’s the topic of the third and final part of this series…