I know that the title of this newsletter is a bit provocative because you must be thinking, “They must be right for someone?” The answer is they are not right for anyone, because they try to fit everyone during many years, some as many as 40 years.
Assets in target date funds swelled to more than $880 billion in 2016, according to Morningstar. That’s a number that’s high enough to scare me. Why am I so against target date funds? There are many reasons; let me share three.
1. Bonds aren’t a sure thing for retirees.
The first problem with target date funds is that they are trying to predict the future by saying when you retire it is a good idea to have most of your assets in bonds vs. stocks.
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We are currently at the end of a long bull market in bonds. If your target date is close, your performance will suffer as bonds decline and interest rates rise; just when retirement is around the corner your account will take a big hit.
Target date funds are meant to become more conservative as you get closer to retirement, because bonds are supposed to be less risky than stocks. While that’s often true, any adviser with 30 years of experience would know this is not always the case, based on history. Interest rates go up and down and the cycle may be long sometimes, but nothing stays the same forever.
2. Multiple fees can hide inside these funds.
The management of these funds can be outrageous. Take a look at what your money is invested in, and you will be surprised you actually own many mutual funds within the same fund company; sometimes 20-25 of their own funds.
Wow, what a great way for the mutual fund company to make more fees: Charge ½% to 1% for the target fund management fee, and then invest the clients’ money in your own mutual funds, which charge another ½% to 1% of fees on top of that.
I hope you are not paying a broker management fees or commissions on top of the internal fees. You must also be careful of the fund company your money is with, because in some occurrences the mutual fund company will charge a sales charge to invest in their funds within the target date fund. I wonder how many investors have no idea this is happening?
3. They do an educational disservice to investors.
Finally, the product’s oversimplification can result in a lack of education for investors about risk tolerance. Understanding your capacity for risk is important, and it comes through good investment education.
A broker may ask you what your tolerance for risk is. If you don’t understand how stocks work and fear the unknown, you tell the broker you have a low tolerance despite being only 45 years old. Then you get steered toward low-risk, low-reward investments, which may not be the best for someone with plenty of time until retirement.
Seventy-year-olds should not have the same amount of his investments in stocks as 45-year-olds. They should have more money in short-term investments, like CDs and money markets, which are available on short notice for medical emergencies and other short-term needs.
This doesn’t mean they should have nothing in stocks, or even a very small amount. Today, 70-year-olds have a good chance of living well into their 80s or 90s. In the U.S., there are about 72,000 centenarians, and that number is expected to more than double in the next four years. So, even at 70, one could easily have another 15 to 30 years to live.
Since my firm invests in value companies that are less risky than many stocks, I feel comfortable with a higher portion of my clients’ assets in stocks (especially including some dividend-paying stocks) in their portfolio.
I always talk about how great Wall Street is in designing products to make you feel comfortable and make them a lot of money. Target date funds were a big winner for Wall Street. They feed off the needs of people who want to do the right thing but don’t know exactly how.
Can you imagine planning your vacation once and never having to change it? That would not work out too well because life changes as time passes. It’s the same with your retirement plans: If you want to have a good retirement you need to spend the time necessary to understand your portfolio. A qualified investment adviser can help.
If you don’t start doing things right now, you will regret it when it’s too late.
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