Events have shown us that TDFs aren't at all what they're cracked up to be. Ron Surz is president of PPCA, a San Clemente, Calif.-based software firm that provides performance-evaluation and attribution analytics, a principal of RCG Capital Partners, a Denver, Colo.-based fund-of-hedge-funds manager, and a co-founder of target-date index maker Target Date Analytics.

Target-date funds (TDFs) have been gaining in popularity, in part because the Pension Protection Act of 2006 made them "qualified default investment alternatives," or QDIAs, for defined-contribution pension plans. TDFs have in fact emerged as the preferred QDIA because of their supposed "set it and forget it" quality and because they're meant improve on investment decisions typically made by participants. But, with the typical 2010 TDF losing more than 20% last year, the current credit crisis has revealed that TDFs aren't all that they're reputed to be. (Recognize that some current retirees are invested in 2010 funds because the practice is to bracket the target date by 5 years, so 2010 funds are for those retiring between 2005 and 2015.) Other articles have purported to address this disappointment, but none of them accurately identifies the real problems with TDFs. These articles hinge on interviews with TDF-company personnel, who provide the same pat explanation for their failure in 2008: the target date is simply a speed bump in the highway of life. Well, it isn't very likely that the truth will emerge from unsworn testimony from the culprits, is it? The emperor's new clothes

The fund companies' claim that TDFs are designed to last the investor unto the grave -- that the fund companies are engaged in the strenuous management of mortality risk -- makes no sense. The truth is that the target-date industry entered into a performance race in 2007, raising equity allocations and justifying the increase as necessitated by longer life expectancies, as though we all suddenly decided to live longer. The timing of course was awful, but even more awful is the cover-up and unwillingness to correct an obvious mistake. TDFs should not be managing mortality risk, as shown in detail below. And faulty rationalization is not the only flaw in TDFs. The designs of every single target-date fund family are flawed in ways that can and should be corrected. Every fund family suffers from the following shortcomings.

Poor risk controlsThe average 2010 fund had a 45% equity allocation at the end of 2008. The typical TDF holds 35% in equities at the target date.
Inbreeding Most target date families are comprised exclusively of funds managed by the fund company. Lack of diversification Most are predominantly US stocks and bonds.
Haphazard glide paths Glide paths are usually justified by simulations rather than solid defensible models. The real world rarely cooperates with simulations.

Some fund families suffer more than others in each area, but all have serious problems in all four. View from the press to the effect that that such-and-such a TDF lost "only" 20% in its 2010 fund is crazy -- no large loss is acceptable in these near-dated funds.

Target Date Analytics, a firm I'm involved with, has created standards that address all of these shortcomings, described here.

These standards is that they are completely and readily investable. The Smart Fund Collective Trusts, offered by Hand Benefit & Trust of Houston, track the performance of the target date indexes developed by Target Date Analytics.

To keep this brief I'll deal here with just one important aspect of the problem: risk control and the crying need to end the glide path at the target date. No TDF currently ends its glide path at the target date, other than of course the Smart Fund Collective Trusts. It would be so simple to make things right, but the fund companies are unwilling to admit their mistake. It's a shame.

With all due respect to David Letterman, I present the Top 10 reasons that TDFs should end at the stated target date.

10. It's how the Europeans do it. The European practice is to end in cash at the target date and roll into annuities.9. It's an important part of delivering on the promise to protect the purchasing power of accumulated contributions.8. Target date funds should stick to just the accumulation phase, and leave the distribution phase to vehicles designed for this purpose, like annuities and guaranteed funds. 7. The majority of participants cash out all or most of their savings at retirement. Participant behavior makes it impossible to manage retirement assets beyond the target date, let alone to death.6. Truth in advertising dictates relabeling target death funds. For example a 2010 fund that is designed for investors who remain 30 years beyond target date should be re-labeled "2010-to-2040", or simply "2040 Target Death Fund."5. Participants perceive that they are protected at target date. How would you feel losing more than a fourth of your savings at age 65?4. The Pension Protection Act has the word "Protection" in it, suggesting that protection is the intent of Qualified Default Investment Alternatives. Good chance participants who are defaulted into target date funds think their money is safe. They don't need someone else to make mistakes for them.3. Academics recommend a glide path that is only in risky assets if and when a standard of living is secured, which for most is never, so the recommendation is TIPS forever.2. The idea is not that the participant remains in safe assets after the target date, but rather that he or she makes an important decision at the target date. Employers see their responsibility ending at retirement, so the participant is on his or her own, and needs to act. 1. It's the right thing to do.

The time for change is now -- for, as the Buddha tells us, "Impermanence is eternal." -FWR

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