If you’re a client of ours or have spoken with us about investments in the last several years, you’ve likely heard us say we do not love target date funds, because they have never done what people think they’re intended to do, and because they’re costly.
The primary selling point for target date funds is convenience. Set it and forget it. All I have to do is put my money in and the fund company will invest it in a more “aggressive” manner while I’m young, and then they’ll make it more “conservative” as I age and get closer to the time I’ll need to sell to pay for retirement. Sound familiar?
Just Sit Back, Pull the Levers and Watch the Money Pour In
It was a stroke of marketing genius on the part of the mutual fund industry. They know we’re overwhelmed by the jargon they print in their prospectus material and disclosures. They know we are easy prey for the lure of a simplistic means to let someone else take the reins of choosing investments. There are roughly 1.8 trillion dollars invested in target-date mutual funds, according to Morningstar. The fee levels vary significantly from one fund family to another, however it’s safe to say the fund companies are making a lot of money with this product. But that’s not the main problem.
The main problem is mom and pop investors, like you and me, that have either chosen these funds for lack of understanding their choices or have been auto-enrolled in an employer sponsored retirement plan that has these funds set up as the default investment. Leading to investors that don’t know what they’re invested in, what the risk of those investments are, or what they’re paying for the convenience of having this auto-pilot fund.
The Nuts and Bolts
Simply put, at five-year intervals the mutual fund companies incrementally move money out of stocks and into bonds. That’s it. That’s what millions of shareholders are paying millions of dollars for every year. Granted, to the layperson, it’s not as familiar as it is for industry folk, but still, rocket science it ain’t. More importantly, bonds are not the “conservative” asset the industry would have us believe. Ask anyone (if you can find anyone), that was invested in bonds in the late 1970’s. They’ll look at you like you’re crazy.
In fact, bonds are arguably riskier now than stocks! The $8.5 trillion that the Federal Reserve has created out of thin air since 2009 has gone directly into bonds, driving their prices up to levels we’d never seen before. But now that interest rates are on the rise, those prices are dropping sharply. The iShares 20 Year Treasury Bond ETF (ticker symbol TLT) has dropped 21% year-to-date and 33.7% from the peak in August 2020. To put that into perspective, the S&P 500 has dropped 13% year-to-date!
2025 target date fund shareholders are in for a rude awakening when they open their May statements. What’s worse, the fees these folks pay for the convenience of the target date fund will exacerbate the erosion of value as interest rates and the bond market become more volatile.
Oh, and by the way, in 2008, a lot of the people who owned 2010 target date funds did not retire in 2010 as planned. Because target date funds didn’t work as advertised then either.
Learn how to protect your savings. No one else can do it for you. But we can help.
P.S. I make quotes around the terms “aggressive” and “conservative” because these too are industry marketing sleight. Personifying the allocation of one’s holdings in publicly traded securities is another Wall Street creation that really grinds my gears. Investing in an “aggressive” fund does not make you more macho, or brave. Taking the time to understand what you invest in and what you pay does. In our book anyway.