COLUMN-Warning: Not all 'target date' funds have the same target

(The opinions expressed here are those of the author, a columnist for Reuters.)

By Mark Miller

CHICAGO, May 27 (Reuters) - If you contribute to a target date fund in your 401(k) plan, you probably have a sense of how it works. The fund's balance between stocks and bonds automatically shifts as you age, with less weight on equities as you get close to retirement.

But it's important to read the fine print on these funds, because their allocations aren't all alike on the "target date" - the day you retire. Some firms that manage target date funds (TDFs) adhere to a "to" glidepath - meaning the funds reach their most conservative allocation on the target date. But the industry's biggest players use a "through" glidepath, meaning that the most conservative position is reached well after retirement.

The difference is important. The "to" glidepath provides greater protection against losses in a market downturn, but the "through" glidepath boosts the odds of stretching your nest egg longer into retirement. Understanding that difference will matter to a growing number of retirement investors in the years ahead. The popularity of TDFs is soaring, with $618 billion invested at the end of 2013, according to the Investment Company Institute - up from $160 billion in 2008.

Glidepath design is a topic of ongoing debate in the fund industry. The latest flareup came when BlackRock, the giant asset management firm and a key proponent of "to" glidepaths, published a paper earlier this month making the case for its approach. The argument rests on the notion that your "human capital" - that is, your ability to earn income - is exhausted on your target date, so there is no reason to be taking more market risk on that date than later in retirement.

"The day that you retire is the riskiest day of your life," says Chip Castille, head of BlackRock's U.S. retirement group. "You're no longer earning, and it's the point when you still have the longest investment horizon and your account balance is likely to be at its highest point, which means any loss you have will be applied to a greater asset base."

Note that this argument isn't about your allocation to stocks and bonds, but how it changes over time. "We aren't saying what your level of equities in retirement should be," Castille says. "If you think stocks will give you high return at low risk, hold a lot of them. But there's no reason to keep gliding past the date of your retirement."

Advocates of "through" glidepaths focus on longevity risk - the danger of exhausting resources in retirement. That's a looming issue for a growing number of households, since fewer retirees will be able to rely on guaranteed lifetime income from defined-benefit pensions in the years ahead. The value of Social Security payments also is projected to fall in the coming decades, the result of reforms enacted in 1983.

Research by Morningstar underscores the importance of longevity risk. "Given lower saving rates and the decline of defined-benefit plans, a growing number of people can't really afford the more conservative approach," says Janet Yang, senior mutual fund analyst at Morningstar. "You can either guarantee you won't have enough and go conservative, or you can have the possible upside of higher stock allocations, which gives you a chance of having enough to last through retirement."

Morningstar's research found that "to" and "through" allocations both can meet retirees' spending needs up to age 85. At that point, results start to diverge. By age 95, 45 percent of investors in "to" glidepaths will exhaust their savings; only 40 percent of investors in the "through" glidepath will deplete their savings by that age.

Glidepath isn't a matter of choice for TDF investors in 401(k) plans; the investing philosophy is determined by the plan provider chosen by your employer. The industry is roughly divided in half on this issue but tilts heavily toward "through" glidepaths measured by assets under management. The three biggest TDF asset managers - Fidelity Investments, Vanguard, and T. Rowe Price - all use "through" glidepaths. Together, these three manage 75 percent of all TDF assets, according to Morningstar.

But it's worth knowing how your plan has you gliding at retirement. If you're not comfortable with the path, you can always move out of the TDF into other fund options. You can manage the allocation yourself, or with the assistance of a financial adviser. "People should be asking what the fund is designed to do," Castille says. "Does it do what I need it to do or not? And if not, make an adjustment."

For more from Mark Miller, see http://link.reuters.com/qyk97s (Follow us @ReutersMoney or at http://www.reuters.com/finance/personal-finance. Editing by Douglas Royalty)