In the mid-1970s, I saw the movie 2001, A Space Odyssey. Everything from large monoliths to ape femurs. I didn't understand it then, and I still haven't figured it out now. What I do vividly recall, however, is thinking just how far off the year 2001 seemed at the time.

But alas, 2001 has come and gone. Space travel, which seemed so amazing then, is taken for granted today. Movie buffs will remember a space jet flying into the center of the wheel-shaped space station in an early scene that was labeled Pan Am. The passage of time certainly has not been kind to Pan Am.

But let's segue from space travel to target-date funds. The first target-date funds were introduced in 1994. Back then, a target date of 2010—the first major target date—seemed extremely far away. But here we are, just 14 months from 2010. Other target dates that may still seem "so far away" include 2015, 2020 and 2025. Yet, of course, just like 2010, they too will come around before we know it.

A large cohort of investors is scheduled to retire in 2010. Basically, these are the folks who were born in the mid-1940s. You will recall that the baby boom is defined as the 18-year time period spanning from 1946 to 1964. Therefore, much of the money invested in 2010 funds belongs to the leading-edge baby boomers, who are now ready to move into the next phase of their lives.

As of late 2008, approximately $26 billion was invested in 2010 target-date funds. As a point of reference, roughly $192 billion was invested in all retail target-date funds. Target-date funds linked to the year 2020 have the single largest asset base, with around $42 billion.

Serious Flaws

So, with the year 2010 right around the corner, it makes sense to ask how 2010 funds are faring in this ugly equity environment. Are target-date funds protecting investors' assets as they approach their retirement date? Have the funds hunkered down primarily in bonds and cash and largely sidestepped the equity market avalanche that began in June 2007 and has yet to let up?

Not exactly. In fact, shareholders are in for a big shock. The four largest 2010 target-date funds (which collectively hold about 90% of all the assets invested in 2010 funds) have each experienced quite significant losses in 2008 (see "Target Pain"). Fidelity Freedom 2010 was down 13% year to date through Sept. 30, 2008; T. Rowe Price Retirement 2010 lost 14%; Vanguard Target Retirement 2010 dropped 11.2%; and Principal Life-Time 2010 plummeted 16.7%.

On average, these four 2010 funds lost 13.7% year to date through Sept. 30, 2008. Consider what a loss of that type of magnitude translates into for a 63-year-old baby boomer who has a $500,000 account balance in the "average" 2010 fund on Jan. 1, 2008. By Sept. 30, the account value in his or her fund had dropped by $68,500.

These funds are nearly one year from reaching their target date. What would happen if investors intended to withdraw their money at the target date and purchase annuities? Isn't it true that the glidepath (the dynamic asset allocation model that governs the portfolio from inception to the target date and beyond) is supposed to guard against exactly this sort of meltdown?

This is a rhetorical question, of course, to which the answer is, "Yes." The reality is quite different.

Consider that the S&P 500 (with its 100% equity allocation) lost 19.3% year to date through Sept. 30, 2008. Many of these 2010 funds, which supposedly have a diversified portfolio and a risk-attenuating glidepath, just barely outperformed a 100% equity portfolio. Results like that point to both a design problem as well as a failure to manage risk properly within the fund. A stated desire to factor in boomers' increased longevity led product manufacturers to err on the side of growth rather than on asset preservation.

Too Much Equity

So what happened? Well, let's take a look at the equity allocation patterns shown in "Target Pain." (Equity allocation is defined as the sum of U.S. equity and non-U.S. equity.) The average equity allocation of the four largest 2010 target-date funds was 52.2%.