Around 41% of all 401(k) savers have are using target-date
mutual funds (TDFs) and the numbers keep rising. Experts in the
financial services industry applaud this trend, but are target-date
funds really the panacea to a secure retirement income?
TDFs attempt to match a person's age and risk tolerance with a
projected retirement date. For example, the Vanguard Target
Retirement 2050 Fund (Nasdaq: VFIFX) is aimed at people in their
mid-20s, whereas the Vanguard Target Retirement 2035 Fund (Nasdaq:
VTTHX) is designed for individuals in their 40s and the 2015 Fund
(Nasdaq: VTXVX) is for people in their early 60s.
According to one study, around 30% of people believe the target
date refers to the year in which the fund's mix between stocks,
bonds, and cash is the most conservative. In reality, the year in
the fund's name refers to the approximate year (the target date)
when an investor in the fund would retire and stop investing in the
fund. As they approach their designated target-date, funds
gradually shift their investment mix from more aggressive
investments like stocks to more conservative ones like bonds.
A major factor influencing the rise of target-date funds
(Nasdaq:TRRDX) is the automatic enrollment of participants into
their 401(k) plan and the plan sponsors' decision to choose
target-date funds as the default investment option.
Despite their noble attempt at helping people to save and invest
for retirement, TDFs (Nasdaq:TRRBX) have many serious flaws that
are being ignored or purposely hidden. Let's examine three quick
1) TDFs encourage the public to be lazy when it comes to asset
allocation. A person's first choice for their retirement
investments should always be a customized asset mix that perfectly
matches not just their age, risk tolerance, and goals, but their
unique investor personality. Instead of delivering that, TDFs dish
up a one-size fits all retirement plan as a default choice.
2) TDF fees are still too high. The average annual cost for
TDFs are in the vicinity of 1%, which is ridiculously inflated for
the amount of actual work these types of mutual funds do.
3) Most TDFs are grossly underdiversified because they miss
market exposure to major asset classes like commodities (NYSEArca:
GCC), global real estate, international bonds, and TIPS.
In my latest
, I talk with Ron Surz, President at PPCA about other big problems
with TDFs. Fiduciaries listen up!
It's true that a TDF default choice is better than nothing, but
it's not better than a customized investment mix that perfectly
matches a 401(k) participant's unique investment needs and
personality. Moreover, the fees being charged by most TDFs are
excessive, which will greatly reduce the retirement income benefits
of the people buying them.
Despite the so-called improvements to glide paths and other
financial engineering to make them better, many TDFs have simply
increased their market exposure to bonds, as a knee-jerk reaction
to the stock market clobbering they took during the 2008-09
financial crisis. How will these TDFs perform when bond prices
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