Boomers who have shuffled out of their pre-2008 investments into target date funds did so because the promise seemed real. Conservative investments with some stocks and a sort of set-it-and-forget-it type of plan that would provide peace of mind. Younger people get them via auto-enrollment when they are newly hired. Either way, these investments have yet to prove their worth. Here’s the three main problems with target date funds.
One, they are funds of funds, a collection of mutual funds that do various things in different ways. Unfortunately, very few mutual fund families are rolling their best performing funds into these retirement tools. And in truth, why should they? If the investment public is buying a fund without too much effort, why throw it into a target date fund.
Two, target date funds are often found and the most heavily used in a 401(k) plan. They have been deigned the fund of the auto-enrolled, the new hire who for whatever reason doesn’t have a clue about how a 401(k) works, wouldn’t use it if they did (statistically, this is why these plans are underused and auto-enrollment has helped boost participation with few people opting out once they were in) and probably owns no other investment. If you have found yourself in this type of fund it is because your employer has done a little napkin math and determined when you will retire based on historic norms for retirement (i.e.65 years old). Those historic norms may not be all that accurate, but it is better than nothing.
Third, because 401(k) plans, at least the vast majority of them don’t allow you to do too much shopping around, you are stuck with the fund that your 401(k) is offering. And this is where we run into trouble.
These funds are designed, at least on that napkin, to do what most of us are not too well versed in doing: asset allocation over time. The idea is that we want to go from aggressively invested in our youth to a more conservative approach in our later years. This journey from capital growth to capital appreciation inside one fund has no real track record to speak of. So at any given time, a handful of target date funds with the same target date could be at different points on this aggressive to conservative investment journey.
Enter the Government Accountability Office or GAO. In a recent report, the GAO was asked (it does not say by whom) to answer the following questions about this investment: (1) To what extent do the investment compositions of TDFs vary; (2) what is known about the performance of TDFs; (3) how do plan sponsors select and monitor TDFs that are chosen as the plan’s default investment, and what steps do they take to communicate information on these funds to their participants; and (4) what steps have DOL and the Securities and Exchange Commission (SEC) taken to ensure that plan sponsors appropriately select and use TDFs?
Without going too deeply into the 59 page report, I’ll briefly answer some of the questions. The investments can vary wildly. In one fund they examined, 65% of its assets were still in common stocks in the year prior to the target date. If the goal is to get your money to a safer place over time, this fund failed to do what it promised to do. But they can’t be faulted for trying to get the biggest return for the investment dollar – and to do that you need to take risks – and hey, their are no guidelines to follow, just a sort of linear point A to point B path.
Performance is indeed an issue. We look back on mutual fund performance three, five, even ten years to glean some information about how the mutual fund performed in good markets and bad, how long the fund manager has been at the helm and how they have weathered the various storms that blow across the investment landscape. Target date funds have no track record to boast about – some have good returns, as much as 28% from 2005 to 2009. Others have lost more than 30% of their value in the same time period. Some have only been around for five years or less.
Chances are, because auto-enrollment put you in that fund and you have nothing to compare it to, in large part because auto-enrollment might make you an auto-investor, it doesn’t make auto-smart about investments. To their mutual benefit, plan sponsors are doing what they can to educate their participants. Some do better than others. But the worker is the one who has to show some interest in where their money is going in order for those educational efforts to work.
The last question the GAO attempted to answer about target date funds, the one about the involvement of the Department of Labor and the Securities and Exchange Commission in the process presents the most problems. A plan sponsor knows their fiduciary responsibility to offer good investments at the best cost accompanied with access to information. It comes down to all parties talking about you in the following way: You can lead a horse to water but you can’t make it a duck.
You have to take an active role in what your plan has to offer. Yes, the improvements in how target date funds operate will happen, and possibly without your knowledge. But this is your money that you are counting on in retirement. Do you really believe that anything in this day and age can be set on a path that lasts 30, sometimes 40 years and not need some attending to?