- Glidepaths are ad hoc. They have no basis in academic theory.
- Holdings are way too risky at the target date.
- They are not vetted. This is not news, but shocking, nonetheless.
Despite their popularity, target date funds (TDFs) have serious deficiencies, like one-size-fits-all, but a few problems are shockingly imprudent and unrecognized. Some TDFs have fewer problems than most but they are not popular.
Here are some shocking facts that you should know about most TDFs.
Glidepaths are ad hoc
As I explain in this article, TDF providers say their glidepaths follow academic theory that maintains constant risk of combined assets through time, combining human capital with investment capital. As human capital depletes with age, the portion of total wealth in investment capital increases.
But as shown in the following graph from the book that launched the theory, actual practice is not even close to academic theory. Profits are the likely reason. Fees are higher for managing stocks and bonds than they are for managing cash.
Who knows what most glidepaths are based on? It’s certainly not this academic theory. But we do know that 85% risky at the target date is way too risky.
Holdings are way too risky at the target date
As shown in the following graph, most TDFs are very risky at their target date, taking the view that stocks and long-term bonds are risky. Consequently, the typical 2010 fund lost more than 30% in 2008 and the typical 2020 fund lost about 15% in 2022.
These funds will not protect in the next market crash. This could lead to lawsuits for excessive risk, especially since TDF selections are not vetted.
TDFs are not vetted
As shown in the following image, the TDF industry is dominated by an oligopoly that is snowballing because fiduciaries—namely consultants—feel obliged to select the oligarchs to be procedurally prudent. Imprudence at the target date is the de facto standard.
Successful lawsuits for excessive fees prove that substantive prudence takes precedence over procedural prudence—most plans chose investments that charged participants excessive fees. Excessive risk for participants near retirement could become the next 401(k) scandal that lawsuits correct. Lawsuits almost happened in 2008, but not much was at stake back then.
TDF assets currently exceed $3.5 trillion, a tasty morsel for the plaintiff’s bar. There are about 37 million participants invested in TDFs. Those near retirement probably won’t recover from a market crash.
Fiduciaries say they want to protect defaulted participants, but they don’t.
Conclusion
Now you know some facts that most don’t know, including retirement savings plan sponsors. That’s shocking!
The good news is that qualified default investment alternatives (QDIAs) are getting better. There is a metamorphosis secretly hatching. Stay tuned.
Sequence of Return Risk—the risk of losing money early in retirement, undermining lifestyle—has been non-existent for the past 13 years. That will change. Even if it doesn’t change, participants shouldn’t be exposed to it. We each get only one passage through the Risk Zone spanning the 5 years before and after retirement.
It’s like “airplane risk” where the odds of crashing are low, but the consequences are calamitous.
So, what’s the point? Check out the more prudent QDIAs. They’re not hiding.
Ron Surz is CEO of Target Date Solutions (TDS), co-host of the Baby Boomer Investing Show (BBIS), and author of the book "Baby Boomer Investing in the Perilous Decade of the 2020s." TDS licenses target-date fund usage of Ron’s patented Safe Landing Glide Path® (SLGP) that actually protects beneficiaries as they approach retirement. Individual investors can follow the SLGP at Age Sage, an educational interactive website. The BBIS educates baby boomers on the risks and rewards in contemporary investing, and Ron’s book is a tour of these shows. He can be reached at Ron@TargetDateSolutions.com.
I don’t know that I would consider these facts to be shocking, at least not in our industry. Most advisors, if they are paying any attention at all, understand the drawbacks of TDFs. The biggest being how aggressive they are. Most investors, on the other hand, have no idea. Until there is a correction in the market, and then they see it first hand. We have some plans that do not have TDFs, but the majority do. We have been so ingrained with the idea that “TDFs are great, and everyone should invest there and then forget about things”, that it is very difficult to get a plan sponsor to go a different direction. Plan sponsors believe it is another way to reduce their fiduciary liability.
Thanks Tim. Good to know that someone “gets’ it.