Beefed-Up Protections May Be Coming for Target Date Funds

Target-date funds - among the most common investment selections offered by employers to employees in 401(k) plans - used to be the darlings of the retirement investment world. They were popular with novice investors because they take the guesswork out of investing. Since the funds hold a mix of assets that becomes more conservative as the target date for retirement approaches, investors don't have to worry about taking on too much or too little risk  as they age. The portfolio rebalancing is done for them.

It seems like a great deal. Except when it isn't.

Target-date funds were heavily criticized during the 2008 market downturn for the massive losses they sustained. Many investors on the verge of retirement panicked because they thought these funds were "safe."  But some funds were found to be too heavily invested in equities for their investors' age, leaving them vulnerable to wild market swings.

The funds have since recovered. But the Security and Exchange Commission is looking to improve certain aspects of these funds to better protect investors' nest eggs.

[ Read: How to invest wisely after 50]

Among the reasons regulators are now taking a second look:

• The risks involved in target-date funds are not well understood by investors (they have risks like most other investments).
• It's difficult, if not impossible, for investors to compare the risks associated with seemingly similar funds because they're so different from one another. A recent study of 36 TDFs with a retirement target date of 2020 found their equity holdings ranged from 35 to 80 percent.
• The risks associated with these funds are underestimated by financial experts.

Some changes that may be forthcoming include beefing up disclosure requirements and marketing materials that would reflect more clearly the risk levels over the life of the fund. For instance, a fund showing an asset allocation that includes a higher percentage of bonds may seem safer, but that description could be misleading because certain bonds are very risky.

Other changes may include expanded illustrations in prospectuses that would:

• Show how the risk level changes over time.
• Reveal how the asset allocation may vary.
• Disclose how other risk management practices may be used to maintain that target risk level.
• Explain the policies and assumptions used to attain the risk level over the life of the fund.

It's not a moment too soon to require these changes, say some investor protection advocates. Target date funds hold some $485 billion in assets, up 29 percent over the previous year. Industry experts predict that target-date funds will account for more than half of all defined-contribution assets by 2020.

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