Public policy debates about the nation’s retirement system will rage this year as legislators consider the impact of the drop in value of equity investments in workers’ 401(k) balances.

At a meeting this week of the U.S. Senate Special Committee on Aging, the president of the Employee Benefit Research Institute (EBRI), Dallas Salisbury, testified on the challenges of securing retirement in a volatile economy. That testimony included data relating to target funds, which automatically rebalance asset allocations and move them to what are believed to be age appropriate. “Had all 401(k) participants been in the average target date fund at the end of 2007, 40 percent of the participants would have had at least a 20 percent decrease in their equity concentrations,” said Salisbury.

This might have softened the blow of the stock market collapse for many people. Salisbury said that based on simulations from 2000 through 2006, if all 401(k) participants had invested in target-date funds with age-specific equity allocations, their median balances would have been larger at year-end 2006. When the most aggressive target date funds were compared to actual participant-directed decisions, the median 401(k) balances for most would have been larger if they had been in target date funds. When the most conservative target date funds were compared to actual participant decisions, the median balances for those up to age 45 would have been larger if they had been in target date funds; however, those over age 45 would have ended up with smaller median balances if they had adopted target date funds.

His remarks underscore the fact that while target date funds have significant benefits (they’re simple in that they relieve investors of the responsibility of figuring out asset allocation, and they’re relatively inexpensive), there are some caveats. Investment manager Paul Merriman points out that most of them are too cautious for young investors, too conservative for many retirees, tend to invest too much in large-cap growth stocks, invest too much in U.S. stocks, and ignore everything in an investor’s life except their targeted retirement date. But he contends that the funds are continuing to improve.

Now that mutual fund companies can talk directly with plan participants, plan sponsors can expect to see a lot of interest from people who have been hit hard and need to make up their losses while keeping risk in check. ###