One of the topics of discussion during the retirement planning conference I attended last month was: Target Date Funds. In fact, it deserved a lunch presentation to the full conference.
Target Date Funds have taken the retirement accumulation market by storm over the last 10 years. In many cases, they have become the 401(k) and 403(b) “default” investments inside these work-site retirement plans at work. Nearly $1 TRILLION is now invested in them through brand-name firms such as Fidelity, Vanguard, TRowe Price, American Funds and so on.
Some firms or 401(k) plans call them Life Cycle funds. I’m sure there are other “marketing” names for them as well. Altogether, there are about 1,645 of these funds offered for sale to investors now. Wow!
But the funny thing is, all this TRILLION dollars happened with absolutely no academic or historic research on how effective this “strategy” may be. None. No research or data. I’ll come back to this in a moment.
If you are not familiar with Target Date Funds (TDFs), they operate on the premise that the further away from retirement one is, the more they should have invested in stocks. And the closer one gets to their target date of retirement, they should have more money in bonds. The target dates are round numbers like 2020, 2025, 2030 and so on.
They call it an investment “glide path”. The glide path typically moves from 80%/20% of stocks/bonds down to 20%/80% stocks/bonds over your working career (while saving for retirement) as you get older. Think of a plane coming in for a landing – it’s slowing down (de-risking).
On the surface that all makes logical sense. Have a “safer” investment mix as you get closer to retirement. The glide path stock/bond mix that you start on… is based on one thing and one thing only – your AGE!
How would you feel if your financial advisor asked you just ONE question prior to recommending a portfolio to plan you retirement around? But what if that one and only question was: “What is your date of birth?”
And don’t even get me started on the history of that glide path going from 80% stocks to 80% bonds at retirement. Would you believe that historical performance (based on 141 years of market history – (1871-2011) and 101 different forty-year investment experiences, actually proves that the exact OPPOSITE glide path gave investors more retirement money.
Yes, owning more stocks (and not bonds) over time produced more retirement savings! In fact, the average additional accumulation was about 20% greater over those 101 forty-year periods. Of course, some periods were worse (about 10% less accumulation) while the best periods were up to 26% better than the average.
Now I’m certainly NOT suggesting anyone should start with more bonds in their 20’s and go to 80% stocks right before retirement. My only point is here is that $1 TRILLION has been invested in an idea, a “retirement strategy” with absolutely no market history or data to support it!
I also won’t write about the many reasons why these TDF portfolios are not the best idea for you to plan your future (or current) retirement with. But if you have them in your retirement plan, I’d think again.
So how did these target dates funds do for folks retiring on or about the year of 2010? Well that retirement target date was just 9 months away from the last stock market bottom of March 2009.
Let’s look at a quick example. I’ll “pick-on” the very low cost, well-known and multi-billion dollar Vanguard 2010 Target Date Fund (VTENX).
A retiree who had $500,000 in their 401(k) at the market peak 2007 thought they would be in pretty good shape with retirement right around the corner. The TDF glide path was systematically selling stocks and buying bonds to prepare for the “big day” when they could hang up their spurs. Their portfolio was on auto-pilot. They were feeling confident!
So even though all 2010 target funds would be highly invested in bonds at this point, he would have watched that Vanguard 2010 target date fund account balance drop from $500,000 to a low of $347,500. That’s a drop of 29.5% just months before retirement. How would you feel about this?
To be fair, the Vanguard 2015 TDF did pretty well (but ONLY if one was brave enough to stick with it in the 2008/2009 negative 51% market drop and stayed fully invested in the 6 year market recovery). However, with a large percentage of the portfolio in bonds in 2013, the fund missed taking full advantage of the 32% stock market gains that year.
In my humble opinion, there are more tactical and prudent ways to plan for retirement and the large majority of professionals at the conference agreed with me as well.
all the best… Mark
Mark J. Orr, CFP
Certified Financial Planner