Age-based funds are replacing risk-based ones as the asset allocation funds of choice at a growing number of 401(k) plans. The primary reason: they are easier to understand.
"We are seeing more interest in the age-based funds," said David Bodmer, principal at Investment Management Consultants Inc., a Portland, Ore.-based consultant to the defined contribution industry. "It's an easier concept for plan participants to understand, and employees don't have to know a lot about investing to use it." He pointed out that many 529 college savings plans use a similar concept, offering funds geared to a child's age and years until they will enter college.
Age-based funds are named by years such as "2010," "2020" and "2030," based on the year a person plans to retire. The fund is automatically rebalanced and adjusted, being more heavily weighted in equities in the early years, when a person is far from retirement, and gradually increasing conservative fixed-income investments as retirement grows closer.
The more traditional risk-based allocation funds require a participant to determine what his or her investment risk tolerance is. Those participants who are able to take on more risk have their money heavily weighted in equities, while those with less risk invest in funds more heavily weighted in fixed income. However, participants with risk-based funds must decide when to adjust their investments, while age-based funds adjust automatically.
"The targeted-retirement-age funds are more popular because they are easier for people to understand," said Stephen L. Deschenes, executive vice president of Fidelity Institutional Retirement Services Co., Boston, whose Freedom Funds were the first age-based funds offered by a 401(k) provider. He said that 63% of Fidelity's 10,000 401(k) plan clients offer Freedom Funds as investment options, with about 19% of those plans' participants investing in them. The Freedom Funds, introduced in 1996, were offered in 10-year increments, but Fidelity started offering the funds in five-year increments last fall.