SEC proposes new rules to make target-date mutual funds more transparent

By Michelle Singletary
Thursday, July 8, 2010; A12

Target-date mutual funds -- investment vehicles that automatically change your mix of assets as you near retirement -- are thought by many investors to be a safer investment choice that's relatively insulated from market gyrations as the funds get closer to the target date.

But lately, people on the verge of retirement have been surprised to see how much these funds have been affected by recent turbulence on Wall Street. In some cases, the funds have performed far less well than had been anticipated.

The Securities and Exchange Commission wants to prevent these surprises with new rules requiring greater transparency with these investments, also known as life-cycle funds.

Many investors, the SEC found, believe these funds become more conservative as their retirement date nears. In fact, the mix of stocks, bonds and cash investments varies widely among these funds.

The funds became popular as a "set it and forget it" strategy requiring little effort on the part of the investor. In fact, the selling point for life-cycle funds was that an individual investor didn't have to worry about rebalancing the assets in his or her retirement fund, as many experts recommend. Instead, the asset allocation and rebalancing are done automatically, as though it were a machine that roasts a chicken and that can be ignored until the bird is done.

Target-date funds were viewed so favorably by the Labor Department that the agency allowed them to be a default selection in 401(k) plans. At the end of last year, target-date funds had $256 billion in assets, compared with $160 billion at the end of 2008, according to the Investment Company Institute. Eighty-four percent of assets in life-cycle funds are held in retirement accounts.

The SEC found that funds with the same target date varied greatly in investment strategies and risks. Losses for 2010 funds ranged between 9 and 41 percent.

"Funds with near-term target dates incurred substantial investment losses, notwithstanding that some investors expected them to have conservative asset allocations in the years leading up to the target date," SEC Chairman Mary L. Schapiro said in announcing the proposed rules. "Imminent retirees invested in 2010 target-date funds saw, on average, 24 percent of their funds' assets evaporate in 2008."

The SEC said that life-cycle funds with the same target date had equity exposures that ranged from 25 percent in stocks to 65 percent. It could be years after the target date is reached before a particular fund's asset mix switched to a more conservative approach.

Under the SEC's proposed rule changes, marketing materials for a target-date fund would have to specifically disclose the asset allocation mix, and this information would have to appear with the fund's name the first time that name is used.

For example, the SEC says a target-date fund with 2020 in its name would have to include a disclosure tag line adjacent to the name, which might be worded: "40 percent equity, 50 percent fixed income, 10 percent cash in 2020." The proposed rule would allow an investment company to list ranges such as "40 percent to 45 percent" in a particular asset class. Schapiro said she's interested in getting feedback on whether such ranges should be permitted.

I would vote against allowing wide ranges. The more specific the companies have to be in disclosing the percentage of the asset mix, the better for investors.

Marketing materials would have to include a table, chart or graph that clearly shows how the asset mix will change during the life of the fund. Investors would also have to be provided with a statement explaining that the mix can change and disclosing when all rebalancing stops.

Most important, investment companies have to do a better job of making it clear that it's possible to lose money investing in a target-date fund. If you read your investment material, you will probably already see language that says something such as "Investment returns and principal value will fluctuate, so that an investor's shares, when sold, may be worth more or less than their original cost." That's the language used for the target-date funds offered in my company retirement plan.

But it's obvious that far too many investors thought these funds came without risk and would set them up for retirement.

"It is clear that investors need more information than just the date in a fund's name," Schapiro said. "They need context in order to evaluate what the date means."

If you want to comment on the proposed rule changes to target-date funds, you have until Aug. 23. You can post a comment at http://www.sec.gov/rules/proposed.shtml or e-mail rule-comments@sec.gov. Include "File No. S7-12-10" in the subject line.

Readers can write to Michelle Singletary at The Washington Post, 1150 15th St. NW, Washington, D.C. 20071.

Comments and questions are welcome, but because of the volume of mail, personal responses are not always possible. Please note that comments or questions might be used in a future column, with the writer's name, unless a specific request to do otherwise is indicated.

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