If most potential clients walking through your door nowadays don't hold target-date funds in their 401(k) plans, that's likely to change in the next few years. The management consulting firm Casey Quirk estimates that such portfolios will account for about 48% of 401(k) assets in 2020, up from just 13% today.

Do target-date funds complicate an advisor's job? Should you recommend that clients adopt the target-date structure? Should you consider other packaged options that don't rely on date-specific portfolios? "For some clients, target-date portfolios make a lot of sense," says Bruce Bills, a planner in Henderson, Nev. "For others, not so much."

Because target-date portfolios hold both tax-efficient and tax-inefficient assets, they may be best for people whose 401(k) accounts are their only investments. And if an investor has only a small amount of money in a 401(k), a target-date fund provides a diversified portfolio that is regularly rebalanced and set on a glidepath to become less aggressive as time passes.

MOVING OUT

Ray Mignone, a planner in Little Neck, N.Y., can understand continuing to use target-date funds for a young person with $20,000 or less in a company plan. But that's just about the only use he can see for the product.

"For clients with assets both in and out of tax-advantaged accounts, I find they're not as useful because of asset-location issues," says Bills, who prefers to have his clients' stock investments outside the sheltered confines of a 401(k) or IRA. "Target retirement funds don't give you that flexibility," he notes.

Moreover, planners say that decisions about asset allocation become more critical as investors get older and have fewer years in which to recoup any losses. For that reason, the amount of equity exposure offered by a fund that is close to its target is a concern. "I myself was shocked at how much exposure to equities some clients have," says Maureen Whelan, a planner in Croton-on-Hudson, N.Y.

T. Rowe Price's target-date fund for 2020 recently had 69% in stocks. Fidelity's fund targeting the same year had about 55% in equities.

"That's a significant difference in the amount of risk you're assuming," says Kevin Brosious, a planner who practices in Allentown, Pa. Brosious sees danger in having that much stock exposure for someone only eight years away from retirement. "I'm not comfortable having them 70% in equities," he says.

For many planners, the first step is to boot the target-date portfolio out of a client's 401(k) and create an all-new allocation. "Most people are happy to have somebody else pick the investments," Mignone says. "They're only in it because they didn't know what else to do."

Although they have been around for almost two decades, target-date funds are increasingly becoming a standard investment for 401(k) plans. According to the latest survey by the Plan Sponsor Council of America, 41.8% of plans now feature automatic enrollment. In those plans, the most common default investment is a target-date fund. Overall, 63.6% of all plans offer target-date funds as an option. The percentage of plan assets in target-date portfolios has quadrupled over the past five years.

If you don't advise clients to sell target-date 401(k) holdings immediately, you do have ways to work around the fund's disadvantages. "First, I ignore whatever the date says," Bills notes. He studies the portfolios to see what they are actually invested in and then chooses additional funds to get the assets and allocation that he has determined are best for a client.

Whelan also tends to disregard the specified dates in client-owned target funds. Roughly a third of potential clients arrive at her office with some target-date holdings in their 401(k) plans.

For those who decide to keep them in their retirement portfolios, she has two approaches for reducing risk. For someone with 30 years to retirement, Whelan may recommend owning a fund with a target date 20 years in the future. Alternatively, she may advise switching existing 401(k) holdings to a more conservative target-date fund but keeping new money in the more aggressive choice.

Some providers of target-date funds justify their aggressive stance by pointing to the dangers of inflation. They contend that a large allocation to equities can help shield investors from the ravages of price increases. While acknowledging that stocks can help offset the effects of inflation, Brosious prefers allocations to TIPS and REITs as a safeguard. "That's where I like to hedge the inflation," he says.

What's more, a heavy reliance on stocks as an inflation hedge can have serious drawbacks, especially given market volatility. "We have some very recent history as to why something like that may not be a good idea," Whelan says.