The future of your 401(k) revealed

The popularity of target date funds continues to gain momentum and will soon absorb the majority of 401(k) contribution, according to a study released Wednesday. By the year 2018, target date funds will attract 63.4% of 401(k) contributions, and will constitute 35% of total 401(k) assets, the Cerulli Associates Inc. study predicts. Target date funds' most appealing characteristic by far is risk management and asset allocation expertise, according to Cerulli. This feature was cited as a very important quality by 84% of more than asset managers surveyed by Cerulli in the fourth quarter as part of the report. Meanwhile, 42% mentioned the funds' diversity of asset classes. “The funds let you choose a portfolio that matches your retirement date, and adjusts the portfolio allocation over time so that you always have the appropriate level of risk,” said Wyatt Lee, a vice president at T. Rowe Price Group Inc. “This solves some of the constant mistakes that investors often make on their own.” These funds, which automatically re-balance to maintain a risk profile that is consistent with a particular target date for withdrawals, such as retirement age, have been growing at a remarkable clip in recent years. In 2005, target date funds held less than $100 million in total assets. After several years of double-digit growth — in some cases as high as nearly 50% annually — target date funds reached more than $500 million in assets as of 2013, according to a report by Morningstar Inc. “The bulk of [inflows] are attributable to [the] Pension Protection Act of 2006, which allows employers to automatically enroll eligible employees in their 401(k) plans and direct the participants' contributions to target date funds,” said Scott B. Smith, a director at Cerulli Associates, in an email. Target date funds that track indexes are increasingly becoming the norm. Assets in such funds grew to 32% of all target date fund assets last year, from less than 4% in 2003, according to the Cerulli report. “Passively managed funds often offer lower expense ratios than actively managed funds,” Mr. Lee said. “Many plan sponsors are choosing passive funds to minimize plan costs for participants.” STAND-ALONE FUNDS SUFFER The biggest purveyors of target date funds include Fidelity Investments, T. Rowe Price, The Vanguard Group Inc. and BlackRock Inc. The growth of these funds is coming at the expense of other investment options. For example, stand-alone funds, which offer investment options tailored to employer's preferences, are expected to see declining market share in the future. Stand-alone funds are most popular among an older demographic. As these investors make withdrawals for retirement, total assets in stand-alone funds will shrink. “Stand-alone funds will remain popular among investors who want more control over their portfolios,” Mr. Lee said. “We still see about 20-25% of assets from new 401(k) business going into stand-alone funds.” Target date funds, meanwhile, are the preferred choice among younger workers. The average allocation to target date funds of those in their 20s is 34.2%, compared with 12.5% for those in their 60s, the report said.