I am on the record about target-dated mutual funds with comments that suggest that this could possibly be the worst investment idea ever. That is a bold statement. But the way these funds play to the inexperienced (and sometimes more savvy) retirement investor is downright despicable.
First, why do I despise this type of investment? Target-dated mutual funds have gained enormous ground over the last several years. Enrollment in these funds have grown 25% since 2005, in part due to the federal government's (pre-Obama) strategy of getting more folks into a plan for retirement. On the surface, as with many initiatives started with that administration, the truth is veiled behind what appears to be straightforward good sense.
Wall Street lobbied heavily for this type of fund and managed to get it crowned as the default fund for those who would not enroll in their company's 401(k) plan. On the surface, this seems like a good idea considering that numerous investors simply allowed the previous default option to kick in with enrollment. That option, usually a money market fund would not, according to retirement experts provide the growth and income that workers would need when they retired.
To get them involved, the creation of this set-and-go investment was granted the status of default in part because the investing public was not capable of making good, age appropriate adjustments to their portfolios (aggressive to conservative) and because of that, would take on more risk than necessary or would do the opposite, not take any risk, stifling the potential growth in those portfolios that could have been achieved.
Folks were not good at rebalancing, a much advised method of fixing your portfolio to align itself with your proximity to retirement. The question of whether rebalancing was any good at all has come under attack with folks like index icon John Bogle suggesting that even though he speaks the gospel of rebalancing, does in fact not do it.
Target-dated mutual funds were supposed to fix this problem. Fund managers would readjust the underlying holdings in an attempt to keep in line with the target for retirement. Fund families scrambled to create funds with a wide range of dates, from funds with a maturity of 2010 on out to beyond 2050.
But without a track record and no empirical proof that these managers could do as they suggested, how was an investor to know that the fund would perform as promised, do as it suggested and retain the same fund manager for the duration. Worse, could it do it cost effectively?
What these funds developed into was a fund family dumping ground. Laggard funds or orphaned funds that investors lost interest in but were still viable enough to hold on were simply enveloped by the target-dated manager. If an aggressive growth fund was faltering, it was invested in by the target-dated fund and added as a percentage of the growth side. Sounds unseemly doesn't it? Even a little deceptive.
The second problem I have with these funds is transparency. While the aforementioned fund dumping is problematic, the fund manager's ability to invest wisely in all markets is always a problem. Proof after the 2008 market meltdown shows a wide range of returns, all with losses and some with so much, a standard S&P 500 index would have handily beat them.
The shortest termed funds, those with a target date of 2010, actually did better but only marginally. These funds lost only 22% of their value during the last year while some with dates as far out as 2050, lost considerably more. Fund managers will point out that the more aggressive underlying holdings in these future dated funds pulled their returns down yet a fund with a mix of stocks and bonds.
Consider the one year return for the Vanguard Target Retirement 2050 (VFIFX). It lost 29.24% over the last year (it has no information prior to that date due to its recent creation - another warning sign of possible problems determining who is the best and who is not). Whereas a fund in the moderate allocation category like Sierra Core Retirement R (SIRRX) actually posted a 13% gain for the same period. While not as inexpensive fee-wise, it also invests in other funds, stocks and bonds both here at home and internationally.
Because investors panic, usually after the fact, these funds have gained a good deal of popularity. This action will come back to haunt these investors. The best solution to this problem - if you insist on investing in these funds is to pick a date for your retirement ten-to-twenty years beyond what you might think of as your retirement. This will allow for some additional growth in the fund and not allow the fund manager to go too conservative too soon. If he/she is doing their job correctly, that is. And that has yet to be proven.