If most potential clients walking through your door nowadays don't hold target-date funds in their 401(k) plans, that's likely to change in the next few years. The management consulting firm Casey Quirk estimates that such portfolios will account for about 48% of 401(k) assets in 2020, up from just 13% today.

Do target-date funds complicate an advisor's job? Should you recommend that clients adopt the target-date structure? Should you consider other packaged options that don't rely on date-specific portfolios? "For some clients, target-date portfolios make a lot of sense," says Bruce Bills, a planner in Henderson, Nev. "For others, not so much."

Because target-date portfolios hold both tax-efficient and tax-inefficient assets, they may be best for people whose 401(k) accounts are their only investments. And if an investor has only a small amount of money in a 401(k), a target-date fund provides a diversified portfolio that is regularly rebalanced and set on a glidepath to become less aggressive as time passes.



Ray Mignone, a planner in Little Neck, N.Y., can understand continuing to use target-date funds for a young person with $20,000 or less in a company plan. But that's just about the only use he can see for the product.

"For clients with assets both in and out of tax-advantaged accounts, I find they're not as useful because of asset-location issues," says Bills, who prefers to have his clients' stock investments outside the sheltered confines of a 401(k) or IRA. "Target retirement funds don't give you that flexibility," he notes.

Moreover, planners say that decisions about asset allocation become more critical as investors get older and have fewer years in which to recoup any losses. For that reason, the amount of equity exposure offered by a fund that is close to its target is a concern. "I myself was shocked at how much exposure to equities some clients have," says Maureen Whelan, a planner in Croton-on-Hudson, N.Y.

T. Rowe Price's target-date fund for 2020 recently had 69% in stocks. Fidelity's fund targeting the same year had about 55% in equities.

"That's a significant difference in the amount of risk you're assuming," says Kevin Brosious, a planner who practices in Allentown, Pa. Brosious sees danger in having that much stock exposure for someone only eight years away from retirement. "I'm not comfortable having them 70% in equities," he says.

For many planners, the first step is to boot the target-date portfolio out of a client's 401(k) and create an all-new allocation. "Most people are happy to have somebody else pick the investments," Mignone says. "They're only in it because they didn't know what else to do."

Although they have been around for almost two decades, target-date funds are increasingly becoming a standard investment for 401(k) plans. According to the latest survey by the Plan Sponsor Council of America, 41.8% of plans now feature automatic enrollment. In those plans, the most common default investment is a target-date fund. Overall, 63.6% of all plans offer target-date funds as an option. The percentage of plan assets in target-date portfolios has quadrupled over the past five years.

If you don't advise clients to sell target-date 401(k) holdings immediately, you do have ways to work around the fund's disadvantages. "First, I ignore whatever the date says," Bills notes. He studies the portfolios to see what they are actually invested in and then chooses additional funds to get the assets and allocation that he has determined are best for a client.

Whelan also tends to disregard the specified dates in client-owned target funds. Roughly a third of potential clients arrive at her office with some target-date holdings in their 401(k) plans.

For those who decide to keep them in their retirement portfolios, she has two approaches for reducing risk. For someone with 30 years to retirement, Whelan may recommend owning a fund with a target date 20 years in the future. Alternatively, she may advise switching existing 401(k) holdings to a more conservative target-date fund but keeping new money in the more aggressive choice.

Some providers of target-date funds justify their aggressive stance by pointing to the dangers of inflation. They contend that a large allocation to equities can help shield investors from the ravages of price increases. While acknowledging that stocks can help offset the effects of inflation, Brosious prefers allocations to TIPS and REITs as a safeguard. "That's where I like to hedge the inflation," he says.

What's more, a heavy reliance on stocks as an inflation hedge can have serious drawbacks, especially given market volatility. "We have some very recent history as to why something like that may not be a good idea," Whelan says.

And the lack of job security in 21st century America is another reason to avoid advising a hefty allocation to equities for someone who may be out of work years before scheduled retirement. In the minds of many planners, all of these factors make target-date funds a poor choice for all but those just starting their work lives.

Yet the agreed-upon fiction that provides the foundation for target-date funds is that a 30-year-old will be employed for another 35 years. Should you even use a client's age as the basis for an investment allocation?



Brosious has clients who are 56 and retired, and others who are 70 and still working. "That's why age probably isn't the best indicator," he says. "I actually consider two things: time to goal and their risk tolerance." To that mix, Whelan adds the client's capacity to take on risk.

With questions of risk looming large, should planners consider using portfolios that are designed to embrace a client's tolerance of returns that are below expectations? There are hundreds of aggressive, moderate or conservative asset allocation choices, including actively managed funds from many prominent companies. There are even multiasset exchange-traded funds that track risk-based indexes.

Michael Hogan, executive vice president of Delaware Investments, which offers three risk-defined Delaware Foundation funds, contends that target-risk strategies are much more easily customized. What's more, they allow the strategy to evolve over time to account for circumstances not necessarily related to getting older, like divorce or loss of a job. "The target-risk-type strategies allow a financial planner a lot of customization for individual investors," he says.

Planners may object that constructing a suitable portfolio is a major part of their service to clients. But for Hogan, there is a bottom-line question that advisors should ask themselves: "Is that time well spent?" The planner, he says, needs to spend a great deal of time evaluating the client's risk profile, and designing a target-risk portfolio requires a full-time focus. What's more, Hogan says, the target-risk structure is "able to accommodate a significantly smaller level of assets than if you went out and individually tried to build a strategy out of a bunch of different funds."

"I prefer to assemble the components myself," says Brosious, who builds client portfolios from passive index funds and ETFs. He sees advantages in indexing, including low cost and data on the betas, and standard deviations of all the components. Because he doesn't actively manage, Brosious avoids having to make bets on various assets, or fretting that someone else is making the wrong move.

For the right investor - typically a young person without substantial assets and without a planner - target-date funds can be useful. "I think they're an improvement over what used to happen," says Bills, who notes that, years ago, 401(k) default investments were stable value funds and money-market portfolios. His concern is, however, that target-date funds' heavy equity allocation, especially in funds close to their stated date, may not be as conservative as many investors think.


Joseph Lisanti, a New York financial writer, is a former editor-in-chief of Standard & Poor's weekly investment advisory newsletter, The Outlook.