A: Target date funds have long been billed as one-stop shops for people investing for retirement. As the years progress, managers reallocate greater percentages of the fund’s holdings into less risky fixed-income investments. But many have long thought that managers of these funds fall short of those goals, including Sen. Herb Kohl (D-Wis.), chairman of the Senate Special Committee on Aging, who has initiated a probe into the operations of target date to determine if they have been investing too aggressively.

A major impetus for the investigation is that some near-term target date funds, such as Oppenheimer Transition 2010, lost over 40 percent of their value in the recent downturn.  Leading up to the crisis, about 60 percent of the fund’s assets were held in equities and 10 percent of its fixed-income holdings were rated below investment grade.

The question of appropriate risk levels is particularly important given that a 2006 law allowed employers more leeway to offer target-date funds as default options for workers who enroll in 401k plans.

The portfolio allocation of T. Rowe Price Retirement 2025 appears appropriate to its time horizon: Its current breakdown is about 6 percent cash, 80 percent equities and 14 percent bond funds. We doubt the fund will suffer adverse effects from any new regulation. But it does seem likely that the government will take steps to better define the level of risk for target date funds and various points in their lifecycle.

Q: What’s the difference between a stable value fund and an asset allocation fund? How are they used?–anonymous, via e-mail

A: The difference lies in the sort of securities in which the two types of funds invest.

Allocation funds divide their portfolios between stocks and bonds based on a preset percentage, geared towards investors with different risk tolerances. Conservative allocation funds might consist of 60 percent bonds and 40 percent blue chips, whereas an aggressive fund might allocate 70 percent to equities and 30 percent to bonds. They don’t offer fixed rates of return nor do they guarantee against losses; they simply try to mitigate investment risk through asset allocation. They’re also available to anyone, regardless of whether you invest through a regular brokerage account or a tax-advantaged retirement account.

On the other hand, stable value funds typically only hold two types of investments: guaranteed investment contracts (GICs) and synthetic guaranteed investment contracts (SGICs). GICs are contracts between insurance companies and retirement plans that guarantee a fixed rate of return. SGICS, also known as wrapped bonds, are high quality, short- to intermediate-term bonds that carry insurance; if the value of the SGIC falls below a preset limit, the insurance company pays the difference. Conversely, if the value of the SGIC rises above a preset ceiling, the fund pays the insurer the difference.

Asset allocation funds are appropriate for any investor with an eye towards holding as few funds in their portfolios as possible. When you find one which meets your risk tolerance, you can essentially buy and hold just that fund and maintain a reasonably well-balanced portfolio. However, unlike target date funds, allocation funds aren’t rebalanced to reflect an investor’s time horizon; holdings are just shuffled to maintain their risk profile. As you move through your investment lifecycle, you’ll need to periodically swap funds.

Stable value funds are most appropriate for investors near or already in retirement. Returns on the funds are usually pegged at very low levels, typically no more than 3 or 4 percent, so younger investors would likely find themselves coming up short in retirement if they only hold stable value funds.

Q: My financial planner told me that there are changes coming for money market funds but she didn’t have many details. Can you explain them? -Bill Whittaker, via telephone

A: At the moment, there are only proposals for changes to how money market funds operate and are regulated. There’s nothing set in stone yet.

Since the sudden collapse of the Primary Reserve Fund last year, it’s become clear that the problem with the fund stemmed from the fact that it held a large position in debt issued by the now defunct Lehman Brothers. That’s led to calls by Securities and Exchange Commission
(SEC) head Mary Schapiro for tighter controls on the types of investments money market funds can make, though details have not yet emerged as to exactly what the proposed investment criteria could be.

Andrew Donohue, director of the SEC’s Division of Investment Management, has proposed dropping the current $1 per share net asset value (NAV) system in favor of a base $10 per share floating NAV system. That idea appears unlikely to gain much traction because it would negate any real benefit of owning shares in a money market fund.

But the most likely scenario is that regulators will further tighten credit requirements for the funds and shorten maximum maturities. It also seems likely that the funds will be required to keep more cash on hand. Realistically speaking, any changes will be largely transparent to investors, though yields on the funds could drop substantially because of these restrictions.

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