The Forgetful Investor

In 1933, Junichiro Tanizaki, Japanese author and novelist wrote and essay entitled “In Praise of Shadows” in which he offers a cultural view of the differences between east and west; where the eastern cultures appreciate light and shadows, the west is looking for clarity. He wrote: “Find beauty not only in the thing itself but in the pattern of the shadows, the light and dark which that thing provides.” Today we are going to take a look at some of those shadows or should I say, those investments that have been pushed to the edge of the conversation.

Today on our daily radio show Financial Impact Factor we visit elocution corner, a feature on this show that deals with a phrase or word that we toss about with great ease without any real foundation in definition. Today’s catch phrase: set-it-and-forget-it.

We have had numerous experts on the show who have suggested that indexing and using ETFs to index the marketplace is hands down the best way to approach the world of investing. In most instances, we view these types of investments as set-them-and-forget them. They offer a simple way to track the marketplace but also provide just enough confusion that using them as the whole of your retirement plan is now consider not only smart but at the same time suggest that it is foolish to construct a portfolio otherwise.

And here’s the problem I have: if your indexed investment for example follows the marketplace, in other words, mimics its performance, and that performance is well-documented as being about 3.2% over the past decade, why is the target retirement return still north of 7-8%?

Ed Easterling of Crestmont Research authored two excellent books on the subject of market cycles—Unexpected Returns – Understanding Secular Stock Market Cycles … and most recently … Probable Outcomes – Secular Stock Market Insights.

In his latest book,  Easterling lays out four points on market cycles and their effects on investors:

• “First, secular stock market cycles deliver returns in chunks, not streams." This refers to the volatility that makes news on a day-to-day basis and the fact that these swings are often much more dramatic that the overall span of an investor's plan.
• "Second, most investors live long enough to have the relevant investment period extend across both secular bulls and secular bears." This is the time span contingent that suggest that the longer you remain invested, the higher the likelihood you will benefit from those swings.
• "Third, investors do not get to pick which type of cycle comes first." Although you may think you can time the market, our emotions still play a role in how we place our goals and what, if any role the media plays in our decision.
• "Fourth, investors need to be aware that they will likely encounter both types of cycles." To this dollar-cost averaging creates a way to master the market swings by purchasing your investments over time and doing so in an even manner.

Easterling continues: "Those who experience secular bears during accumulation are generally better prepared than investors who are spoiled by a secular bull. A secular bull market is a pleasant surprise to retirees who endured a secular bear on the way to retirement. For retirees who grew to expect a secular bull during accumulation, the unexpected secular bear can be considerably disruptive.”

So I ask my cohosts: is set-it-and-forget-it an investment strategy? Listen to the conversation here.

TDF: Still not Convinced about Target Date Funds

I have a box and it is blue. By description you can imagine exactly what you need to understand that what I have, although key details about size and shape are left blank and the shade of blue is not fully described. But you get the idea that there is a container and the color is one of the primary ones evoked by light having a spectrum dominated by energy with a wavelength of roughly 440–490 nm.

Suppose I have a target date fund and it suggests I will retire in 20-years. Much like the blue box, most of what you need to know about this mutual fund is essentially portrayed in the name. Unlike other mutual funds, whose name seeks to tell you how the fund manager(s) will invest your hard-earned cash in a confusing jumble of confusing terms, target date funds convey a simple message of here and then. Here is the fund you want to get you to a then you need.

Unlike the blue box, there is far more at stake and because of that, a simple title for the investment is easy to understand but at the same time, so deeply layered and nuanced, that it makes the real investors wary and new investors complacent. Recently, Scott Holsople, president and CEO of Smart 401(k) wished that something as simple as a name could do it all for everyone. he wrote: "At Smart401k, we spend much of our time thinking about how to explain things in a manner that’s relatable to the average participant (i.e., someone who doesn’t live and breathe investing and its terminology)."

Don't be jealous Scott. I have yet to find a single redeeming quality in TDFs. Cobbled together and containing questionable funds, they are hoisted on the 401(k) public as the be-all-to-end-all investment, making not only the plan sponsor feel a fiduciarially warm and fuzzy but giving the plan participant the impression that they need do nothing more.

Three things wrong with target date funds that folks choose to ignore.

1. The target is often wrong. If you are young, just starting out and auto-enrolled (which is how these things became popular and abundant in the first place), the target date you choose has little to do with your actual retirement date. It still hinges on the seemingly outdated 65 years old-and-done thinking. Which leads me to...

2. Everybody's target is different. If you are a blue-collar worker for example, the target might be accurate; but not so if you can work beyond. So the glide path, a nice word for "we don't know what we are doing and it has never been done before so use this imagery to explain it how we're going to get you from point A to point B", doesn't apply. Which leads me to...

3. What these fund managers do, none of whom will stay with the fund until it reaches retirement, none of whom invest in the fund and none of whom can explain exactly where the fund is relative to the benchmark (that doesn't really exist) is charge more than a similar portfolio of index funds or even a balanced fund and do so without a track record. Give us your underinvested, your newbies and your (by-choice) dumb investors and we will give them the way and the light, they seem to suggest. Suppose twenty years done the road you find yourself with far less than you assume. What then?

Only a few people have the nerve to speak out against these investment because they seem okay on the surface, they do get folks involved and the risks seem low. But they are going to disappoint more people than they help and I'd be willing to wager that in the next 10-years, folks will sour on the notion and realize that investing in the markets needs to be as simple and as low cost as possible and while TDFs seem simple, they are really just dumbed down versions of what could be something far more engaging. TDFs are an excuse for not educating yourself about where your money is going. Which in and of itself is a bit of a shocker.

Good news/Bad news

While we have all been, on occasion, asked to choose between the good news and the bad news, when it comes to your 401(k), both sides of the question mean something. Today, I'd like to look at some of the good news, bad news that has been coming out of the world of the 401(k).


Investments
Good news: People continue to contribute to their 401(k). A recent Investment Company Institute report found that only 2.4% of investors using this sort of plan did not contribute in 2010. This is considered a generally good statistic for two reasons: the resurgence of the company match may have prompted more people to begin to contribute more in 2010 than they did in 2009 (3.4% ceased contributing) and two, the stock market rewarded these folks for doing so. This means that account balances also increased.

Bad news: Those who did continue to invest actually pulled money from the equity side of the investment equation. The ICI was confused by the pattern, which typically dictates that when the stock market does well, investors tend to increase their holdings rather than withdraw. The shift they suggest may point to a lower risk tolerance which doesn't necessarily explain why there was an increase in international exposure.


Risk
Good news: There is a much clearer understanding of the risks involved in the investment world. Although there are still a sizable number of senior investors (those at least 65-years-old) who are willing to take above average risks with their portfolios, most recognize the danger in doing so.

Bad news: too many younger folks are unwilling to assume risk via equity investments. While 10% of the 65-year-olds reported they take on above average risk, their counterparts in the  35-to-49 age group admitted that they do as well. Defining above average risk is often difficult to do. Related to a balance of investments, with popular sentiment suggesting a gradual decrease in more volatile investments (equities) to more conservative ones (bonds, fixed income), this group may be making these adjustments too soon in their investment lives. If, as popular sentiment suggests that we will work longer, a 35-to-49 age group could possibly be leaving a certain amount of aggressiveness untapped. If you are thinking that you will work until 70[years-old and beyond, a 35-year old should invest in much the same way as 25 year-old would have just ten-years ago.


Better 401(k) choices
Good news: There has been over the last several years, an acknowledgement of sorts from the plan sponsor world that better choices for their participants is directly correlated to the types funds offered. Fees dominated the conversations held by plan sponsors and administrators as those that used their plans turned their focus on how much each investment was costing them. Plan costs eat away at potential returns. So many plans reduced the number of funds offered and with those reductions, the types of funds offered. The shift to a larger selection of index funds and target date funds may have helped create a better investment environment for those using the plans.

Bad news: As fees were lowered amongst the plan's offering, the plan itself became more expensive. This change in how the fees are levied make both the newly low-cost funds offered simply appear as if this were a bait and switch. Fee disclosure will only increase in the coming years as the Department of Labor looks to better reporting of these costs. The trouble is you may not where to look and may be able to little about these costs. You can sue over poor investment choices. But unless you actually leave the company you work for, the 401(k) you have is what you are stuck with.

Turnover

Good news: The turnover rate in the mutual funds offered by your company's 401(k) has dropped somewhat over the years. This is reflective in the choices. Index funds have near zero turnover, rebalancing only when the index shifts. Target date funds tend to shift in a similar way but don't offer the investor anyway of knowing how much is being turned over in the funds within the funds.

Bad news: While turnover is often equated with higher fees, a certain amount of this activity is generally considered acceptable if the rate of return is increased as a result. Most investors will shift their money into a fund based on the size. And the larger the fund, the more cumbersome investing becomes and because of that, the lower the turnover.


Target Date Funds
Good news: Target date funds have increased in plan usage from a scant $57 billion in 2000 to almost a trillion dollars invested in 2010. The good news here is limited to the success of the fund families marketing strategies and the required auto-enrollment of new hires. Add to that the financial debacle of 2007-2008 and numerous investors in 401(k)s simply saw the risk in these self-directed plans as too confusing. Turning to target date funds seemed on the surface to be the most logical conclusion for most.

Bad news: Target date funds still have some hurdles to jump through before they gain my seal of approval - no that they are necessarily currying my favor. They remain murky at best. Most target date funds, with the exclusion of those that comprise of index funds only, are a fund of funds. This suggests that a fund family, rather than close a poorly performing mutual fund, simply roll the fund into a target date fund. Because of this, there are still transparency issues. Add to that the suggested target date may not be your target, that no two target date funds are at the same point in investment holdings (risk) as a similarly dated cohort, that there is no fund manager who can offer conclusive evidence that this is the best method of rebalancing and lastly, that most users tend to set-it-and-forget-it.


Fees
Good news: As I mentioned, they have dropped over the last several years. But most investors still make assumptions that fall squarely into the "if it is an index fund, then it must cost less". This lower cost is mostly true and is  normally attributed to index funds, even though some smaller index funds that track the S&P 500 charge considerably more than their larger counterparts for the same investment. Even with that in mind, an investor can build not only a well-balanced portfolio using index funds alone, they will do so at a much lower cost than any other investment portfolio in their plan.

Bad news: Most target date funds act as if they can do what they do for less, they don't. Some target date funds have expenses and fees that are well north of 0.80%.


Participation
Good news: more folks are using their options across more age groups and accessibilities. Most mutual funds are held inside 401(k)s by twice compared to those held outside. Add to that the growing number of average to lower income households entering this market for the first time using this sort of investment.

Bad news: Education still has a long way to go. Trusting, finding or using an advisor is still the purview of the more affluent investor. The average balances in these plans increased but it suggests that was a result of an increase in the stock market value rather than an increase in participation or contributions.

Target Date Funds: The Downsides of Bundled Investments

Here’s the three main problems with target date funds.

One, they are funds of funds, a collection ofmutual 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?

It's 2011: Do You Know Where Your Bond Mutual Fund Is?

Almost every investor in the country owns a bond. This ownership might be via bond mutual funds, investments in individual bonds be it corporate, government or municipal, or through the widely used target date funds. Each is prone to its own troubles.

Bond mutual funds, even though they are managed by expert managers, may be so burdened by the underlying investments as to hide or mask the trouble that may be brewing in this market.

Individual bonds are influenced by the health of a company, the ability of the government to retain its high credit rating or in the case of the municipality, pay off the debt it is owed to those who invested.

Target date funds, the darling of the auto-enrolled 401(k) participant may contain the most trouble in part because you don't have a good bead on what is owned and in many cases, in what proportion.

There are some essential elements of a bond that many simply do not grasp to its fullest. Not the least of which is the effect that interest rates have on these investments. In short, bonds are loans and the way these borrowers pay you back is with the agreed upon interest. Many bond issuers simply refinance those bonds to pay that interest. But what if the interest rate isn't favorable to such financial restructuring?

So let's talk interest rates for a moment and some of the assumed beliefs you may have.


The trickle up effect
We often put a good deal of the emphasis on the Federal Reserve bank and their presumed control over all interest rates. They lend to the largest banks in what is called an overnight rate. Banks increase that rate to consumers at each level of lending, the last rung being the consumer loan for a mortgage or a personal loan.

Those rates are determined by demand, the market forces at play and in many instances, inflation and/or governmental budgetary needs (deficits). The Fed looks at money supply, the other half of the demand equation and depending on how much is circulating - too much and the interest rates remain low, too little and they increase. Sometimes.

Sometimes fear increases those rates as well. Growth forecasts and a strengthening economy normally lead to more demand for capital which leads to higher interest rates. Add to that the increasing possibility that inflation will rise as well. gives everyone who borrows the jitters. They know, should these things happen, the Fed will raise interest rates in the name of stabilizing the economy.


The emerging market conundrum
The world is global - while an oxymoron as a stand alone phrase, it represents a growth not previously seen in the decades prior to this one. Emerging economies are building at a pace that is much faster than anyone anticipated. Much of this growth is coming from China but there are numerous other economies doing the same thing on a slightly smaller scale.

The flip side of that growth is investment and investment needs money and countries, faced with growing populations who no longer worry about saving, instead shifting to spending, force borrowing. This will increase interest rates - probably sooner than we expect. many of us have experienced low interest rates for so long, we consider it to be the norm.


Consumers: should you save or should you spend?
The most common answer is to spend. Popular economic theory is that if consumers fail to spend, the economy will languish. This is actually not the whole truth. If interest rates are low, it would pay for infrastructure improvements much more cheaply than otherwise - and these improvements are necessary if corporations expect to become more efficient in their production of goods and services.
The bottom line, a healthy savings rate actually adds to the improvements that need to be made. It doesn't suggest that folks won't spend. But it does prompt companies - at least in theory to do a better job enticing you to do so.


Is mortgage deductibility important?
Possibly but the impact is lower and more specific than many suggest. Lower interest rates on home loans entice borrowers to buy more house than they need, refinance to increase their debt and those actions pour more money into the economy. Yet at the same time, estimates of lost revenue to the federal government have been estimated to be as high as $104 billion a year.


Raise those interest rates
No doubt, we expect interest rates to remain low. But they should be inching up. According toRichard Dobbs, director in McKinsey’s Seoul office and a director of the McKinsey Global Institute (MGI) and Susan Lund is director of research at MGI, higher interest rates would "also limit financial bubbles, restraining speculative and heavily leveraged investment while encouraging more investment that would actually raise the economy’s potential growth rate, such as expanding the country’s broadband network, developing new green technologies, and rebuilding aging infrastructure."

The authors of that report also suggest, a rightly so, that "higher rates would also focus executives’ attention on the return that companies earn on their capital, prodding them to make sure they get more bang for each buck. This could boost the nation’s productivity, which is the key to raising standards of living over time."

Does this point to a bond bubble?

Not necessarily so. What it does however is seduce investors into thinking that all is well and bonds do not come with risks. Gus Sauter, chief investment officer of The Vanguard Group, the largest U.S. bond mutual fund manager with $413.6 billion of fixed income assets as of Dec. 31 wrote that he is "increasingly worried that people aren’t aware of the risks in the bond market. The problem is that when you’re at historically low rates, as we are now … yields aren’t likely to go significantly lower, and at some point when the economy does strengthen, they’re likely to push higher.”

This does suggest that bond investors are overbought, denying the risks involved and ignoring the potential, even probable readjustment in this corner of the market. Will it burst as a bubble might? Not likely but the slow hiss will take the least experienced investors by surprise and it may be too late by the time it happens for them to do much of anything.

With one exception, possibly two. Increase your equity exposure is one. The other, buy short maturities. This last one might make it difficult for individual bond holders to ladder their portfolios. But at least you won't be stuck with bonds that are worth less in an inflationary period.

More than Just Mutual Funds: A Peek Inside your 401(k)

There is no such thing as a simple choice.  We may be very familiar with the options available and we may know a large amount of details about those choices.  But when faced with making the decision, we often freeze, unable to decide and even questioning the whole process.

Just get behind someone at a fast food drive-up window and wonder how long does it take to order from a menu that rarely changes. Your 401(k), the defined contribution plan that many of us have, puts us in the retirement planning drive-up lane and forces us to make a choice.

Few people ever decide to drive on through without making a selection.  Once in the line, you are sandwiched in by the person in front of you, the car behind you and the prohibitive curb. This is your 401(k). This is your 401(k) menu.  Order now, pick-up at the second window, pay at the first and be satisfied with your choice in large part because there is no going back, no changing your mind or adding something else on to the pick you have made (without exiting your vehicle, which defeats the whole purpose).

This is where almost every 401(k) plan in this great nation fails.  Once you have been put in the drive-up lane, you are stuck. You are essentially given a select number of choices, many of which are easy to determine how much they cost in part because your plan is now loaded with index funds, which basically resembles your dollar menu.  Cheap and (portfolio) filing without a lot of extras.

Then the seniors portion of the menu, also bland (and bond-like), suggests that you can get value from your invested money by making sure you get your dollar back - or at least in theory. The kids menu has gotten smaller over the years your plan has existed because there is fear that if this portion of the menu were too large, you might find the restaurant liable for (actively managed mutual funds) choices that were too expensive and fraught with risk.  They could throw in a toy but you would want proof that you could purchase this item without ever being dissatisfied.

So they offer you menu items that you wouldn't expect.  These are items that would be better suited at a sit-down establishment where the big spenders go - not because they want to spend more, they just want to think they are more sophisticated than the general population.  This is the ETF (Echange Traded Funds) choice.

And then we have the value meals.  This portion of the menu dominates the process and in effect, bogs most of the line down if there should be someone who is indecisive. These are your target date funds, a combination of mutual funds tucked under one banner which suggest that you can pick a year in which to retire and the item you choose will not only be worthwhile, but will also fulfill its promise.

Everyday, folks drive up to their 401(k) plan and are forced to make a choice.  Everyday, your 401(k) plan is scrutinized by regulators. Everyday, 300,000 advisers go out to the field and, well for lack of a better word, advise.  That's 300,000 different drive-up windows, sponsored by just as many employers for millions of employees.  A daunting task indeed.  Which is why you are dissatisfied with the choices: you think that there is a better drive-up window someplace else.

Of those 300,000 advisers, the vast majority of them, according to Fred Barstein, the president of 401k Exchange "half have one employer plan. Half of those have at least three plans. Fifteen thousand or so, or about 5%, have at least five plans. Then there's the 5,000 or so elite advisers, who have at least 10 plans, $30 million and at least three years experience."  Mr. Barstein, who is also columnist for the Employee Benefits Adviser site, suggests that the fees that these advisers charge have dropped significantly in the past several years, which is good for the participants but makes it doubly difficult to make a living doing this sort of work.

Not only is the competition stiff, the drive towards least expensive and lowest risk has sliced the revenue stream in half. You might think this would be good for you, the 401(k) plan participant. Turns out, it hasn't been as good as you thought it was.  In this particular scenario, these sorts of plans have become more generic, less customized and inelegant.

When an adviser approaches your employer, the sell goes something like this: You want almost zero liability, almost zero costs, and near zero effort on your part and I, the adviser, will do this by offering target date funds and perhaps a huge basket of index funds and, if we can figure out how to squeeze one in, an annuity.  None of these offers your employees any guarantees, the adviser might suggest ,except for the annuity, which illustrates a distribution of retirement income and unfortunately comes with a cost (a trade-off of sorts).

Is it any wonder why you sit at the drive-up menu for longer than you should?  All of the choices look the same. And then there is the problem of getting you to order the product best suited for you. Here is where they suggest a sort of buy one get one free (or the matching contribution). By the time you get to the drive-up window, you may been sitting in line, waiting your turn for almost a year.  Then to get the other half of the buy one, get one free offer, you may have to wait an additional period of time (a vesting period that can be more time than you planned on staying with the company to get).

Then there is the super-fast lane where you are essentially put on a bus, driven through without access to the window at all.  The driver, your employer in this example, orders what they believe is best suited for you - take it or leave it. In this situation, you will be dropped into a target date fund and told that you can opt out (go hungry) or stay in and believe that this menu choice is probably the best one for you because someone thought it might be.  That someone is the adviser.

Now Mr. Barstein does suggest that at its rawest, it is about selling. Selling a plan involves training, partnering and a constant source of information. Much like fast food drive-up windows, who might consider your health as a passing interest in order to get you to come back, increase their bottom line with a salad and offset fears that their choices are not the best ones available (doing it yourself will always be more satisfying but more time consuming as well), your 401(k) plan is designed to fill you up.

The adviser and the plan sponsor hope you drive off happy and satisfied.  As long as you drive off and don't sue them.

Trash Talking Target Dated Mutual Funds

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.

A Target-Dated Mutual Fund Critic

John Bogle, father of the index fund and founder of the Vanguard Group, keeps his portfolio allocated based on his age, believes that buy and hold is still relevant, and does not feel as though target-dated mutual funds represent stewardship (instead he suggests they represent salesmanship).

Calling what he does the Bogle Age Allocation, he actually believes that Social Security is enough of a bond fund for the average investor. Build your own target-dated fund he tells us largely because he worries that these funds are not what they seem and as I have suggested numerous times, they are as yet proven.

A Stern Warning From the SEC - Just in Time

In a recent address at the Mutual Fund Directors Forum Ninth Annual Policy Conference, Mary Shapiro, SEC Chairperson announced her problems with target date funds. As you know from previous posts here, at the previous address of this blog, on my website and on our retirement blog, these funds are not as yet advisable alternatives to a portfolio built on your own. And even if the temptation to allow these types of funds, which in short look to some far-off future date that you pick for your retirement and readjust your risk and holdings to make sure that you grow increasingly conservative with your investment dollar, turn out to be what they sy they will do, there are far too many issues right now.

In her address to these fund managers, the much tougher than the previous eight years of SEC chairpersons told them of her concerns. She said: "Growth in target date fund assets is likely to continue since these funds can be default investments in 401(k) retirement plans under the Pension Protection Act of 2006. More than 60 percent of employers now use target date funds as a default contribution option, compared with just 5 percent in 2005.

"However, target date funds have produced some troubling investment results. The average loss in 2008 among 31 funds with a 2010 retirement date was almost 25 percent. In addition, varying strategies among these funds produced widely varying results. Returns of 2010 target date funds ranged from minus 3.6% to minus 41 percent."

This single acknowledgment should send alarms ringing throughout the mutual fund world. No longer is business as usual, I'll-turn-my-head-and-let-you-do-what-you-want-to type of enforcement. No longer is this simply the wishes of Wall Street over the fiduciary responsibility of those managers, who lobbied mightily for the Pension Protection Act of 2006, which more or less mandates the use of these funds.

She offered a clear cut objective instead for her agency "that SEC staff is closely reviewing target date funds’ disclosure about their glide paths and asset allocations. The staff also is examining whether the same target date funds underlie both retirement and college savings plans. The staff has been working closely with the Department of Labor in light of target date funds’ prevalence in participant-directed retirement funds. This important issue has also been an area of focus for Chairman Kohl and the Senate Special Committee on Aging."

As I have mentioned before, many of these funds lack clear transparency of just how they plan on achieving their promised results. I have accused the industry of dumping orphan and unwanted funds into the portfolio of these funds to keep some investor's money on the table while sacrificing others in the process. The fees are still much higher than they need to be. Ideally, they should be closer to the index level, charge no 12b-1 fees, and offer more succinct projections of what is to come. Mae West once suggested that “An ounce of performance is worth pounds of promises.” Ms. Shapiro, to her credit wants more.

Her final warning: "While you do your part, we at the SEC will do ours. We will consider whether additional measures are needed to better align target date funds’ glide paths and asset allocations with investor expectations. Among other issues, we will consider whether the use of a particular target date in a fund’s name may be misleading or confusing to investors and whether there are additional controls the SEC should impose to govern the use of a target date in a fund’s name. As we pursue this analysis, we will have a special focus on the expectations of the millions of everyday Americans who use target date funds to invest for retirement and educational needs."

Good luck Ms. Shapiro but I believe the wind is at your back on this one.