This is a guest post by Neal Frankle, CFP ®. Neal found himself in a financially fragile situation at the age of 17. Both his parents passed away while he was still in high school, leaving behind a small insurance settlement. Neal sought out a financial advisor to help him invest his nest egg so that it would help put him through college. Instead, the advisor charted a self-serving course and was on the verge of burning through the money when Neal realized what was happened and fired him just in time to avoid losing everything.
The experience had a deep impact on Neal and formed in him a lifelong desire to help people learn to make smart financial decisions. Today, with more than twenty-five years of experience in the financial services industry, Neal is an author and avid blogger. To learn more, visit www.wealthpilgrim.com
Target date funds are very popular but maybe they shouldn’t be.
A target date fund is a mutual fund that is supposed to ratchet down risk as you get older. It turns out many haven’t really done the job they are designed to do. This has cost investors billions of dollars in losses.
Here’s a great article explaining how these funds work .
A quick way to get your hands around this is by way of example. Let’s say you plan on retiring in 2015 and you want to reduce risk as you get closer to your “gold watch” date. In this case, you might be tempted to buy a “Retirement 2015″ fund.
The fund is supposed to automatically rebalance a portion of your money out of stocks and into bonds each year as you approach retirement. In theory, it sounds wonderful but unfortunately, it hasn’t worked out for some people.
It turns out that “rebalancing” and “asset allocation” mean different things to different fund managers.
This came to a head last year when similar target date funds generated a huge range of (negative) returns.
Most people think that all target date funds are the same. They aren’t.
Look at the target date funds for 2010 for example. You’d expect a “Retirement 2010″ fund to be pretty conservative…right? Well….the best performing 2010 fund was DWS Target 2010 Fund – it only lost 6.22% in 2008. As you can see it was conservative – the fund had 85.36% of its assets in bonds.
DWS Target 2010 Fund
|OVERALL PORTFOLIO COMPOSITION (%)
The worst performer was the Oppenheimer Transition 2010 Fund. It dropped 40.16% in 2008. Guess how much it had it bonds? Only 30.49% as you can see below:
Oppenheimer Transition 2010
|OVERALL PORTFOLIO COMPOSITION (%)
Granted, last year was horrible for just about everyone. But if target date funds are supposed to be managed similarly, how can you explain the divergence in returns?
The answer, as you can see, is that each fund managers invested very differently.
There isn’t any uniform definition of what should be included in these funds. No guidelines. No nothing. It’s like selling great tasting yogurt by telling all your customers that its fat-free…..only it isn’t. Do you remember that Seinfield episode when that happened? It was very funny.
Unfortunately, you aren’t laughing now if you invested in a target date fund that didn’t do its job.
Congress isn’t yukking it up either. Sen. Hernb Kohl, D- Wis, chairman of the Senate Special Committee on Aging is leading a congressional probe into target funds. The SEC is also looking into the matter. They are considering increasing governmental oversight or even restrictions. These officials fear that some mutual fund companies are just slapping a “target date fund” label on just about anything and the government wants it to stop.
Why should you care about this?
Most of the $152 billion invested in target date funds are invested through 401(k) plans. If you participate in a plan at work, you might even be investing in target date funds.
What can you do about it?
You have two choices. First, you could try to get information from the fund by reviewing the prospectus. It generally details what the investment restrictions are.
The second option you have is to take the bull by the horns. Forget about using these funds until uniform standards are put in place. If you know what kind of risk you are willing to take simply mix and match your funds to suit your own needs.
Don’t invest blindly. The target date fund is a great concept that Wall Street has once again screwed up.
Not all of these funds are lousy. Just make sure if you do use a fund like this, you know what “target” the fund is referring to. It might be you.
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