While lawmakers focus on the transparency of 401(k) fees, Dow Jones Columnist Robert Powell suggests they pay more attention to the default investments allowed by last year’s Pension Protection Act. Powell notes that the usual suspects: target date, by which investors choose portfolios that morph slowly as they approach retirement, and target risk, though which investors decide what level of risk they are willing to take, but does not significantly change. “The two types of mutual funds that will soon become the default investment options for millions of Americans come with some drawbacks,” Powell wrote. Citing a study by Boston University School of Management Professor Zvi Bodie, Powell notes that target date funds fail to factor in any risk tolerance, therefore forcing investors to choose asset allocation based on only one of three portfolio factors: time horizon, while ignoring investment objective and risk tolerance. Likewise, Bodie’s study notes that target risk funds fail to factor in time horizon. That is not to suggest that either type of fund is a poor choice for retirees, Bodie wrote. “Empirical evidence suggests that a simple [target date fund] would be an improvement over the choices currently made by many uninformed plan participants,” the paper says. Still, they are not perfect. Target date funds work best for middle-aged employees, he said, who can tolerate some risk. But for those who are highly risk averse, or early in their careers and prone to change jobs or industries frequently, target date funds might not pay off. Bodie suggests a “safe target-date” option, perhaps included Treasury Inflation Protected Securities (TIPS). Because TIPS mature in a certain year, and pay interest based on inflation, they are more certain than money-market funds, and always beat inflation. Powell urges lawmaker to consider Bodie’s case for TIPS, and takes to look seriously at asset allocation for automatic enrollment. The staff of Money Management Executive ("MME") has prepared these capsule summaries based on reports published by the news sources to which they are attributed. Those news sources are not associated with MME, and have not prepared, sponsored, endorsed, or approved these summaries.
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