My Big Problem with Target Date Funds: Opinion

The actual 'target date' has little meaning

401k, target date funds, retirementWhat'll it take to hit dead center?

We have stringent labeling requirements with consumer and food products. If they’re “Made in the USA” they must include ingredients and/or parts to support that claim, or suffer penalties and sanctions from the Food and Drug Administration and the Federal Trade Commission.

It’s therefore sad (and concerning) that there are still no similarly stringent labeling requirements for target date funds. The retirement nest eggs of countless participants are at risk when the next bear market hits.

As with many financial products, target date promises didn’t deliver in the crisis of 2008. They were supposed to be a one-stop-shop style of mutual fund that would shift its asset allocation to fixed income as investors grew closer to their target retirement date.

We can argue about what the actual target date should be (retirement or death, go or through) and whether the asset allocation should automatically shift on some arbitrary date. Yet the biggest problem with target date funds is that they had no labeling requirements, so participants were led to believe that a 2015 or 2020 fund had little or no equity exposure during the crisis, only to then suffer huge investment losses.

A 2020 fund from Vanguard could have a totally different glide path and equity mix than a 2020 fund from Fidelity. As an example, 2010 target date funds lost an average of nearly 24 percent in 2008, according to the SEC. Losses ranged from 9 percent to a whopping 41 percent. That’s a 32 percent difference for participants that were supposed to supposedly be in roughly the same investment boat, retiring in 2010.

A comparison of target date 2015 funds conducted in 2010 by Morningstar showed that the Alliance Bernstein 2015 Retirement fund had an allocation of 71 percent stocks, 28 percent invested in bonds and 1 percent cash; and the Vanguard Target Retirement 2015 fund was 60 percent stocks, 37 percent bonds, 3 percent cash.  The 11 percent difference in the weighting of equities is rather large.

So the “target date” therefore has little meaning. I’m reminded of Ty Webb’s answer to Judge Elihu Smails in Caddyshack, when the latter asked Webb how he measured himself against other golfers if he didn’t keep score. The sarcastic Webb said he measured himself by height.

So if the 2020 in a 2020 target date funds didn’t stand for a specific equity percentage, the participant would only know the fund’s underlying ingredients if they read the prospectus. We know how often that happens.

I believe there should be labeling requirements to show the equity/fixed income mix, preferably next to the fund’s name in marketing materials. Until then, I’m still wary of the popular product.

Ary Rosenbaum is an ERISA/retirement plan attorney for his firm, The Rosenbaum Law Firm P.C. At a flat fee, Ary helps plan sponsors reduce their plan cost, facilitate administration, and limit their fiduciary liability.

2 Comments on "My Big Problem with Target Date Funds: Opinion"

  1. Do not need a label Ary if you look at the TDFs with BDTOOLS as it looks right down to actual holdings and can compare apple to oranges or even to custom on over 107 data points. Then yes label them as well aligned with clients’ needs including their demographics. Try it.

  2. “Target date fund” describes a methodology, not a specific asset allocation breakdown. It shouldn’t be surprising that different companies have different formulas or glide paths, different advisors do the same. The SAME advisor probably uses different glide paths for different clients, based either on the client’s information or their personal preference.

    I spent 15 years helping participants in the large and medium market sectors; IMO the introduction of TDF’s, and their use as default investments for those that don’t choose otherwise, has led to a vast improvement in likely outcomes. Previously, default choices were most often cash/money market options, which are a poor fit for the vast bulk of participants.

    TDF’s are not perfect, but better than the previous alternative.

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