Target date funds (TDFs) were first introduced in the early 1990s by Barclays Global Investors (BGI) and were originally used for college savings plans. The target date, for example the 2020 fund, is an event date. In the case of college savings plans, it’s the year that a student intends to enroll in a college. Target date funds’ asset allocation mix typically provides exposure to return-seeking assets, such as equities, in early years when risk capacity is higher, and becomes increasingly conservative as time progresses with exposure switched progressively toward capital-preservation assets, such as short-term bonds. This asset movement through time from more to less risk is called a “glide path.” Eventually, target date funds began to be used for retirement savings plans, especially 401(k) plans. The event date in this application is the year in which an investor intends to retire.

Usage of TDFs remained minimal until 2006. Two major events brought TDFs to the forefront. First, behavioral scientists recommended that 401(k) plans use automatic enrollment to encourage participation. Employees would need to choose to be excluded from the plan, whereas they formerly needed to sign on for the plan. Behavioral scientists were right. 401(k) participation skyrocketed, but this created a new challenge. Many 401(k) participants were either unable or incapable of making an investment decision so they defaulted to their employers who, typically, placed their contributions in very safe assets, like cash. This led to the second major event: passage of the Pension Protection Act of 2006 (PPA).

Subsequent to the PPA, target date fund assets grew from $0 to about $150 billion in just two short years. This set the stage for serious disappointment in 2008 when the typical 2010 fund lost 25%. The market crash of 2008 exposed the fact that far too much risk was being taken, especially near the target date. Note that the 2010 fund is designed for those retiring between 2005 and 2015. Participants who defaulted their investment decision to their employers believed they were protected, especially near retirement, so they were devastated and shocked. As a consequence of this pathetic loss, the U.S. Securities and Exchange Commission (SEC) and the Department of Labor (DOL) held joint hearings in 2009, and subsequently threatened to regulate TDFs in a variety of ways, specifically by requiring more disclosures. At the time of this writing, these threats remain to be carried out. In the meantime, nothing of consequence has changed since 2008, other than some minor improvements in fees and diversification. The vulnerable participants remain in as much jeopardy today as they were in 2008.

The good news about 2008 is that not much was at stake, with $150 billion in TDFs, which was less than 10% of 401(k) assets. The next 2008 will be devastating by contrast, and it’s not a matter of if – it’s a matter of when. At the time of this writing, TDFs hold $1 trillion, which is about 25% of all 401(k) assets.

There have been 522 ERISA-related fiduciary breach cases since late 2013. The significant breaches include self-dealing, imprudent investments, failure to submit contributions, and failure to diversify. The good news for plans with TDFs is that a high percentage of lawsuits deal with excessive fees, so courts have not yet addressed the selection and monitoring of TDFs.