Subscribe to this BlogWill the feds fix target-date funds?
Sometimes a great notion just doesn’t live up to its promise.
That’s certainly true for target-date retirement funds, which are all-in-one portfolios that automatically shift to grow more conservative by your retirement date. A staple of 401(k) plans—and the default option for most new investors—many target funds underperformed badly in the market meltdown. The typical 2020 portfolio dropped 30% last year. Worse, many shareholders in 2010 funds, who were poised to retire, got hit with similar losses.
Question is, who’s going to fix target-date retirement funds, and how?
Cue the federal government. On June 18 a hearing on target-date funds will be jointly held by the Labor Department and the Securities and Exchange Commission, which may eventually lead to new rules for these investments.
According to SEC chairman Mary Schapiro, who laid out the agenda for the hearing before a House financial services subcommittee earlier this week, regulators will examine the different asset mixes held by target date funds, which led to widely varying results. Among 2010 funds, Schapiro noted, returns last year ranged from -3.6% to -41%. The SEC and Labor Dept. will consider "whether additional measures are needed to better align target-date funds' asset allocations with investor expectations," Schapiro said.
Regulators will also look closely at whether a target-date fund’s name might be "misleading or confusing to investors," Schapiro said. Not that there’s much question about investor confusion. One recent survey (pdf) found that 62% of investors polled thought “investing in a target-date fund means you will be able to retire on the target date.”
That would seem an obvious conclusion. But instead fund companies assume you will keep your money in your target fund for another two or three decades after retirement, instead of cashing out immediately. So the funds often hold a large stake in stocks, anywhere from 40% to 70% of the portfolio, until the retirement date, only then downshifting to bonds and cash.
Why assume such a long investing timeline? For one thing, higher stock allocations enable fund groups to tout better performance records, since historically (if not lately) stocks have delivered higher returns than bonds. The strategy is also a way to make up for the poor savings habits of 401(k) participants, since many fail to contribute enough to build adequate nest eggs.
Of course, taking greater risks to chase higher returns can easily backfire—just look at last year. As one would-be hearing witness, Joseph Nagengast of Target Analytics, wrote in his comments to the SEC (pdf), “If a fund labeled 2010 is really targeted to ‘land’ at 2040, it should be re-labeled as a 2040 fund.” (You can read comments from other experts seeking to testify at the SEC's website.)
If any reforms do result from these hearings, they would likely focus on improved disclosure of target-date risks. But regulating asset allocation is more difficult. Even financial experts disagree about the proper portfolio mix of stocks, bonds and other investments. Will a government agency be a better judge?
Still, it's clear by now that these investing choices should not be left up to the fund companies that market target funds, or employers, who aren't financial experts. The best solution, as some 401(k) critics have pointed out, would involve guidance from independent fiduciaries, whose only concern is the interests of the fund shareholders—perhaps a federal retirement board should take on the task, as Vanguard founder John Bogle has suggested (pdf).
Meantime, a few fund groups are seeking to get ahead of any federal regulations by making their own changes. Schwab announced last month that it was reducing the amount of stock held by its target-date funds. Its 2010 portfolio, for example, shifted from a 50% stake in stocks to 43%. Other firms that have made similar fixes include Aim and OppenheimerFunds, according to Financial Research Corp.
It's a start.
I recently had my investment advisor suggest that I invest in a target fund. Irresponsible? I think so especially after reading tons of information on these funds…… Makes me feel like I'm being suckered!
Wow, Thanks Mike. You Summed it up perfectly. The problem with this whole mess is people passing the buck. Yes you hire a financial professional for help with your finances. But it is your responsibility to understand what they are doing with your money. To blindly give someone your money and expect stellar returns with low risk is naive.
Would you leave your kids at a day care without any idea what they do during the day? Of course not…
Well maybe those who do have found 30% of their kids missing and want to blame some one besides themselves….
I completely agree with Ron from Pittsburgh. I have served as a Regional Sales Director with a major investment firm for over five years and currently have all my retirement money in target date funds. (well over 500k). People like Shawna need to educate themselves on their own investments. That is the only way to protect yourself from unscrupulous advisors. If all target date funds performed exactly the same, then we would only need one option. There are zero guarantees investing, but if there is one guarantee that I am comfortable making is that the federal government further involvement in the mutual fund industry will increase fees for everyone and have zero positive effect.
Why should the Feds fix Target Date funds? Aren't there regulations about having a prospectus? Isn't the investor supposed to read it? And to think that we were going to let these people "invest" their Social Security. At some time, we have to be responsible for our own investments.
Scott, I can have a great repoire with someone and not trust them with a dime. I don't really think allowing financial advisors to act in a way contrary to their clients best interests to line their own pockets should fall into the category of "just how things work." When I hire a financial adviser saying I'm extremly risk averse and retiring in 2 years, I expect them NOT to invest all my money in products that are extremely risky (stocks) in a target date fund dated 2010 with the assumption I can leave my money there until 2040 (as the article indicates was happening with these products).
I'm fine with paying an advisor a set fee for their services. HOWEVER, when they also make commissions (on top of the fee) for steering me toward products not appropriate for my situation, I have a problem with that. It's unacceptable.
Well, we can quibble about whether target funds strategy is perfect, but it's clear, to me, their strategy is a heck of a lot better than most investors can come up with themselves. How many people get wiped out each year because they have up to 100% of their 401k in their company's stock? Or are 30 years from retirement and have 100% of their 401k in a cash account because they think they're being "safe"?
There's a lot of statements in this article that make little sense. For instance, "The typical 2020 portfolio dropped 30% last year." This is presented as a problem. Why? It's a 2020 retirement strategy, we're 11 years away from any type of withdraw that would lock in losses. In 11 years, you may not even remember what happened in 2009. What if by 2012 we've recouped all losses and are at new highs? Was it still the wrong strategy? Do you remember 11 years ago what happened in the 1998 market? How relevant is that now?
The strategy is designed for long term returns, not avoiding a single bad year. Also, the comment "Worse, many shareholders in 2010 funds, who were poised to retire, got hit with similar losses." This shows, again, an ignorance of the act of retiring. It seems to assume that someone retiring in 2010 will need 100% of their funds the second they retire and therefore will lock in a 30% loss. This isn't how it happens, a person shouldn't withdraw more than about 4% of their funds in any given retirement year. Most of their money will still be invested for decades after retirement; you do not dramatically change your investment strategy or withdraw all your funds on your retirement date; in fact you should change your strategy very little, and no more than any other year, just a little more conservative each year. They still have decades to recoup this temporary loss.
I'm always shocked by the ignorant articles that are written on these sites. Are these people even educated in basic investment theory? These hysterical reactionary articles based on the headlines of the day instead of a cooler-headed multi-decade viewpoint just prove to me how amateurish these authors are, just at the very time we need them to give perspective to nervous investors. Instead, they're running around as if their (collective) heads were on fire.
I'm retiring in 10 years, lost more than 30%, and haven't changed my strategy at all. Instead, I've continued to plow money in the market at the same exact rate as before the blowup. I admit it was more stomach churning than I anticipated (I knew when I started investing that I would have a year or two like this, it's just part of the game), but I was able to keep my head when others, such as this author, are losing theirs. I'll be very happy when I retire I not only didn't panic and sell at the low, but that I continued investing at bargain prices.
I agree with one comment below that target funds cannot be both appropriate for college savings and retirement, because the college funds are withdrawn much more rapidly and thus should become much more conservative, more quickly, and earlier, as they approach the target date.
Shawna- to your point about advisors more interested in lining their own pockets:
In every profession, this occurs. Your tell me that doctors, dentists and attorneys recommend client solutions that are the least lucrative solution to their goal? Hardly. My advise to you- go find an advisor that you develop good repoire with.
It would seem obvious to me that this is a great case for (drum rolly please) a professional advisor. This advisor will assist in setting up your asset allocation properly for your specific situation, not just based on 1 fact- your target retirement date.
They also use target date funds for college savings plans. Why would anyone ever assume that someone whose child is going off to college in 2010 would keep the money in the account until 2040? That's misleading and against the very clear interests of the investor. Simply unacceptable.
The financial system is so screwed up and wrapped up in its own self-interest that I don't see how the Feds can fix it. We hire "professionals" for services/ guidance in areas that are not our personal expertise. However, when we hire a financial advisor, they seem more interested in lining their own pockets (fees/ commissions) than our interests. Until this issue is rectified, regular people don't stand a chance.
People , it's time that anyone who hopes to retire with any kind of financial security dump the crooks ( whether brokers selling products for firms they are associated with , or Wall Street selling the stock market which is a " scam " )that have costed many investors their lifesavings . If you were fotunate to have been invested in the stock market during 1982 through before the tech bubble burst of the 1990's chances are that building a retirement portfolio was a " no brainer " profitable way ( with effortless saving money on your part )of reaching your retirement goals . Many did invest their money and it grew . The problem with some of those investors is that if their money was entrusted or changed hands to " greed " and or that money wasn't protected from market losses ; retirement plans changed . How much money you will need to retire depends on your financial circumstanses . I have a 401k that holds 1/4 of a million dollars that most of is money that I had saved . I'm retired and haven't had to pull one cent of it or money from other small investments . I get a defined pension and have paid healthcare . I pay my monthly expenses out of the account that my pension is directly deposited into. My point is that you'll do a lot better at building your retirement by saving your money . In my 401k I'd rather get a 5 1/2% return on my money by it setting in my employers plan than take a 10 , 20% or more loss without a saftey net " shooting craps " in a stock market that has you set up to fail .