Improper Use of Target Date Funds
October 16, 2009 by Mr. GoTo
Filed under Investing for Retirement
I was an early adopter of target date funds (also called retirement date funds). They seemed like an easy way to implement a long term investment strategy without having to regularly re-balance your portfolio. I’ve since changed my mind.
What is it that these investors are doing wrong? Only 19% of target date investors had put 80% or more of their retirement nest egg into the fund. That is counter-productive to the essential purpose of owning a retirement date fund.
Do these folks not understand that a target date fund is a “fund of funds” with a mix of different asset classes that are supposed to be ideal for the long term investor? Yes, the allocations change over time, but that is also part of an accepted retirement investing strategy. If you aren’t confident in that strategy, you are probably making a mistake in owning any part of a target date fund.
According to the survey results, 60% of those who do not use target date funds properly say that they “don’t want to put all of their eggs in one basket.” That explanation is a non-sequitur because a retirement date fund has eggs distributed among multiple baskets.
I’m guessing that these confused owners of target date funds simply do not understand how they work and what the purpose is. If they did, they would either not own such a fund or they would really own it and invest a substantial majority of their retirement assets in the fund. By only going half-way, they are defeating the purpose and value of owning the fund.
My reasons for no longer owning a target date fund are these:
- Most of these funds do not invest in enough asset classes that are non-correlated. This causes them to be excessively sensitive to general market declines.
- Some are too expensive to own compared to simple index funds.
- There is no consensus as to what an ideal or proper stock/bond allocation ratio should be for a given retirement date horizon.
- I think I can do a better job selecting index funds that are low cost and that conform to our needs and risk tolerance.
Target date funds seemed to be a great idea for the “set and forget” retirement investor. The results have not lived up to the hype. Without better education of investors in how to use these funds for retirement investing, they can end up doing more harm than good.
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Just last month I wrote a series of article for our local paper on target date funds (http://www.personalmoneyplanning.com/ourviews.aspx?LinkId=90864&spid=18788). As they both are becoming the “standard” fund in many 401k plans and also terribly disappointed many investors last year, I think the more folks learn about these the better. Thanks for your article.
I am new to this site. Looks interesting so I have bookmarked it. Generally agree with your comments on Target Date funds. Actually investors may be smart not to put all $ in a Target Date fund as these are new and don’t have a long term track record. Maybe as they gain experience they will either jump in or out completely.
I know (or think I know) enough about diversification, low cost, asset allocation, re-balancing, safe withdrawal amounts, adjusting equity risk down with age etc. My wife has no clue and no real interest in learning. Would rather see her in a Target Fund rather than risk being preyed upon by Stock Brokers, Annuity salesmen etc.
Good Luck with the site and with retirement