Target date funds are exploding in popularity. Net flows surpassed $41 billion in the first three quarters of 2007–up from a total of $34 billion for the full calendar year in 2006, according to Financial Research Corp. (FRC). The growth is driven in large part by increased use in retirement plans as employers try to steer participants to funds more likely to provide income replacement at retirement. "There has been a surge of interest," says Michael Doshier, vice president of marketing for retirement products at Fidelity Investments. "In fact, most inquiries we get from plan sponsors are about target date funds."

The Labor Department did a lot to increase the funds' popularity when it sanctioned target date funds, also called lifestyle funds, as one of three qualified default investment alternatives (QDIAs) for automatic enrollment. Long awaited by plan sponsors, the DOL ruling, which clarifies provisions of the 2006 Pension Protection ACT, accelerated a shift from sluggish money market funds to somewhat riskier, but still relatively low-risk, target date funds. "Target date funds are now the most common default," says Lori Lucas, DC practice leader at Callan Associates. A recent Callan survey of 90 large plan sponsors showed that about 36% offered these funds at the end of 2007, up from 32% a year earlier.

So what's the ultimate design for target funds? For one thing, according to a recent JPMorgan Asset Management report, two key goals should be kept in mind: diversification of assets and downside protection. The appropriate mix could include extended and alternative assets such as emerging equity, emerging debt, direct real estate, real estate investment trusts and high-yield, fixed-income investments, says Anne Lester, managing director and senior portfolio manager of JPMorgan's global multi-asset group. "Not all target date fund designs are created equal," notes Lester. "A well-diversified portfolio, which achieves a better balance of risk and return, is more likely to get participants to income replacement safely,"