Fifteen years ago, the first target-date funds were introduced. Back then, a target date of 2010 seemed far in the distant future, but now it's a mere seven months away. As this anniversary nears, we looked at how well target-date funds will have executed their mission of delivering investors' money safely on the shores of retirement.

The money invested in 2010 funds largely belongs to the first wave of baby boomers, those born in the mid-1940s. As of Dec. 31, 2008, there was about $20 billion invested in 2010 target-date funds. To put that in context, a total of $152 billion was invested in all retail target-date funds as of the end of the year. Target-date funds linked to the year 2020 have the single largest asset base, at some $32 billion.

It's important to note that assets going into target-date funds doubled since the 2006 Pension Protection Act made these vehicles a "qualified default investment alternative" (QDIA) for savings in 401(k)s and similar tax-deferred plans. That means that employees who haven't indicated investment preferences can be automatically enrolled in target-date funds, on the grounds that they are safe default vehicles. This makes exploring their safety all the more relevant.

Big Shock

So, are target-date funds protecting investors' assets from the current market maelstrom as they approach their retirement dates? Have these funds hunkered down in bonds and cash, and sidestepped the tidal waves that began crashing in June 2007 and have 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 "Bumpy Landing," on page 26). Fidelity Freedom 2010 was down 25.3% through the end of 2008. T. Rowe Price Retirement 2010 lost 26.7%; Vanguard Target Retirement 2010 dropped 20.7%; and Principal Life-Time 2010 plummeted 30.3%.

On average, these four 2010 funds lost 25.7% through Dec. 31, 2008. Consider what a loss of that magnitude translates into for a 63-year-old baby boomer who had a $300,000 account balance in the "average" 2010 fund on Jan. 1, 2008. By year-end, the account value in his or her fund had dropped by $75,000. Compare this with the 5% loss sustained by the On Target 2010 Index, a target-date index designed and maintained by Target Date Analytics (TDA). (Full disclosure: I am a principal of Target Date Analytics.) The performance of the On Target 2010 Index in 2008 sets a standard for how a 2010 fund should behave as it closes in on its target date.

What went wrong? Let's take a look at the equity allocation patterns in "Bumpy Landing." (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 51%. Compare this with the equity allocation of the On Target 2010 Index (OTI), which was only about 8%. Clearly, the OTI fund has a far more conservative glidepath than the others. This prudent approach produced a year-end loss of only $15,000 in an account that had a $300,000 balance at the end of 2008 compared with an average loss of $75,000 for the other target-date funds.

The average target-date fund has a larger allocation to equities than the defensive OTI at every stage of the glidepath (see "Equity Exposure"). However, as the target date approaches the OTI becomes considerably more risk averse than the average target-date fund.

TDA has built indexes for the following existing target dates: 2010, 2015, 2020, 2025, 2030, 2035, 2040, 2045 and 2050. The On Target Indexes primarily are based on passive index funds and ETFs. The asset allocation model of the OTI are distinctive in two important ways. First, the indexes are broadly diversified across eight asset classes, including U.S. equity, non-U.S. equity, real estate and diversifying assets, fixed-income products and cash.

Second, the glidepath (or asset allocation model) of the OTI emphasizes risk control as the target date approaches. This is particularly true in the defensive model, shown in these charts. There is also a conservative model, a moderate model and an aggressive model for each target date.

In addition to being benchmark indexes, one can invest in the OTI models through a series of target-date funds that have been built by Hand Benefits & Trust to mimic several On Target Indexes. There are currently five available: SMART Funds 2010, SMART Funds 2020, SMART Funds 2030, SMART Funds 2040, and SMART Funds 2050. (For more information, visit bpah.com/products/inst_trust_serv_factsheets.htm.)

In 2008, all four 2010 titans fell considerably short of the performance standard set by the On Target 2010 Defensive Index. (The On Target 2010 Conservative Index had a return in 2008 of -13.05%, which was considerably better than any of the four largest 2010 target-date funds. The OTI 2010 Moderate Index had a return of -20.89%, while the OTI 2010 Aggressive Index returned -29.06%. Thus, the Vanguard 2010 fund could be classified as having moderate risk, while the remaining three funds would be categorized as aggressive.)