A column in The Wall Street Journal citing research circulated by the National Bureau of Economic Research criticizes target date funds’ one-size-fits-all approach.
Author Mark Hulbert’s gripe is that glidepaths consider too few variables, something reflected in the research.
“Many assume that the proper glide path for a target-date fund is a simple matter of extrapolating historical return and volatility data into the future,” he writes. “In fact, however, dozens of additional factors are relevant when determining whether a given glide path is optimal for a particular investor.”
He then describes an expanded view of sequence of returns—or the risk of retiring into a down market where assets are withdrawn at lower valuations for living expenses and therefore unavailable for an eventual rebound. A potential reduction in income from a job loss, in addition to portfolio assets, must be considered, something current glidepaths fail to do effectively.
“Thus, determining proper investment allocations needs to take into account not just the stock market’s historical return profile but also your age and the vulnerability of your job to the business cycle,” Hulbert adds. “That is difficult enough with just a few variables, but becomes almost impossibly complex when incorporating many additional factors.”
Critics counter
While not perfect, some critics countered target-date funds are adequate for most savers and better than the do-it-yourself allocation and rebalancing alternative. Others claimed the criticism stems from a desire on the part of advisors to use more expensive managed accounts.
“Sigh. I’m not saying TD funds don’t deserve scrutiny, but I can think of about 10,000 aspects of the finserv industry that are more worthy of criticism. These funds really simplify things/improve outcomes for a lot of people,” Morningstar’s Director of Personal Finance Christine Benz tweeted.
“TDFs are under intense criticism because advisers want to sell managed accounts,” Certified Financial Planner Brian Allen, Founder and Chairman of Pension Consultants, tweeted in response.
Bob Seawright, producer of the popular Better Letter weekly e-newsletter, reinforced the imperfect but better-than-nothing argument, noting that exercising also has risks but is certainly preferable to not exercising. It’s a point Hulbert eventually concedes, quoting researcher Jonathan Parker, a professor at the Massachusetts Institute of Technology.
“In any case, Prof. Parker hopes that this new study will not be interpreted as being overly critical of target-date funds,” he concludes. “He says that these funds represented a big improvement over what came before. The point of this new research is that ‘we can do a lot better. It can’t be optimal to be average.'”
With more than 20 years serving financial markets, John Sullivan is the former editor-in-chief of Investment Advisor magazine and retirement editor of ThinkAdvisor.com. Sullivan is also the former editor of Boomer Market Advisor and Bank Advisor magazines, and has a background in the insurance and investment industries in addition to his journalism roots.
The BIG problem with this study is its reliance on simulations. If we could live life thousands of times over, we could take more risk. The conclusion of the study that TDFs are too safe for those in retirement is just plain wrong — TDFs are actually way too risky. . Please see https://401kspecialistmag.com/dont-fail-to-protect-financially-naive-401k-beneficiaries/
If people were to use a financial professional rather than be encouraged to leave funds in a former retirement plan with no professional advice, this problem would, for the most part, go away. It is my opinion, that the myriad factors that should be taken into consideration for a person in retirement or approaching retirement, is way too complex for a one-size-fits-all portfolio. Do-it-yourself investors, who many times are too cheap to want to pay a professional, beware. You don’t know what you don’t know until it is usually too late. Those folks will be the first to file complaints against their FORMER employer rather than taking responsibility for their own ignorance. There are exceptions to every rule, however, they are few and far between.
The problem here is that 401(k) plans are conceived of as retirement plans, which they are emphatically not. They are simply deferred compensation plans, almost all of which allow their participants some latitude in choosing how their accounts are invested. The purposes for for which compensation is deferred is saved and invested is, then, largely up to the participants, most of whom are ill equipped to both to plan for the future and invest accordingly. The true retirement plan is a defined benefit pension plan, now going the way of the dinosaur, The 401(k) “retirement” plan is a fraud.