The results of a recent survey of consultants to defined contribution plans (401(k)’s) revealed what I believe illustrates the dichotomy between reality and the world of professional money managers. The investment consultants polled said that they believed that plan participants who are at retirement age can face losses of no more than 5% in target date strategies if they are to meet their retirement income goals. Target Date Funds (TDF’s) are mutual funds commonly available in 401(k) plans that are designed for investors retiring on or near the date in the title of the fund. The fund will automatically adjust the asset mix as the shareholders age. It is intended to be a diversified, all in one, no brainer solution for retirement saving.
We back tested a diversified series of index fund portfolios over the last ten years. If one was to experience no more than a 5% loss over that time period, then the most aggressive asset allocation that could have been used would be about 10% stocks and 90 % bonds. We also surveyed all of the 2015 Target Date Funds in the Morningstar data base. One would assume that a 2015 TDF would be designed for those imminently facing retirement. The average 2015 TDF was 42% invested in stocks. The range for the 34 funds was 21.14% to 61.23% stocks! So, no 2015 TDF was conservative enough to avoid more than a 5% decline in value in a severe market decline like 2008-2009. Many would have (and did) experience far greater losses.
We have maintained for some time that there is a disconnect between professional money managers and the retirement plan participants that they serve. Most target date funds are invested much too aggressively for the clients that they are supposed to be designed for. We routinely must ratchet back the date range by 5 to 15 years to find a fund that matches our client’s risk tolerance.
We continue to like target date funds and include them in the 401(k) plan investment menus that we design. We urge caution in their use, however, and recommend that participants chose the fund in a target date series that matches their risk tolerance and ignore the date. We also sincerely wish that the professionals who manage target date funds would survey the risk tolerance of their shareholders rather than relying solely on Modern Portfolio Theory to determine their asset mix. What they find may cause them to be more cautious with their clients’ money. For more information on target date funds and using them in your 401(k) see my previous posts on the subject.