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.
Author: Jeremy Vohwinkle
My name is Jeremy Vohwinkle, and I’ve spent a number of years working in the finance industry providing financial advice to regular investors and those participating in employer-sponsored retirement plans.
Although it's important for the government to investigate products that are purposefully harmful to investors, it's also true that no one cares about your money more than you. A finance manager is fine taking in 3% from several clients, so you'll never see the same care put towards your portfolio as you can do for yourself.
If it's in your 401k, you would know about it if you reallocate your assets every 6 months as recommended. 401k's themselves are questionable at this point.
whatever decisions people make when it comes to putting their money into anything - they should at least understand and research where that money is going into. I agree with James - this is something people can do themselves.
Thanks for the post! I knew there was variance between fund companies on asset allocations, but I didn't realize that the differences could be this huge! I have the Vanguard 2035 fund, but I read the prospectus and I'm comfortable with the asset allocation. Once again, the consumer needs to do his or her own research.
Reading the prospectus is like reading the nutrition labels on food. The marketing may say it's healthy, but if the cereal is chock full of high fructose corn syrup, it really isn't healthy and shame on the buyer for beliving the hype.
Thanks James and OI. I agree with you both. If nothing else, I think most people GET IT. We have to take responsibility and get involved.
Excellent post. It is absolutely ridiculous to count on these funds to do the work you could do in 10-15 minutes per month. It shows a level of apathy that is truly sad. Just tweeted this post out to my followers as well.
Excellent job bringing up something that doesn't get enough attention.
Personally, I'm a big fan of (low-cost, indexed) target retirement funds. But it's absolutely essential for investors to read the prospectus, take a look at the asset allocation--both now, and what it is supposed to be in the future--and make sure it lines up appropriately with their own goals and personal needs.
Unfortunately, the truth of the matter is that most investors aren't going to take the time to read a prospectus. I think many of the oversight/regulation suggestions that John Bogle has been championing lately make a lot of sense.
Well said. This is another reason why I don't like these types of funds. You are right on the money.
Problem is, even if you are retiring in 2010 you still need to have a decent amount in equities to beat inflation. So, the bottom line is you need to review the funds composition and decide if the risk is worth it. If you are 90% in bonds when you retire that could be too much...