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Retirement with a Plan: A Target (-Dated Fund) that missed the Mark March 4, 2009

Posted by retirementwithaplan in retirement.
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I have referred to target-dated funds as cesspools of bad funds who could exist on their own, tossed into a big mix-master and segmented according to risk. A pinch of aggressive growth to offset a 030309str_2009trgtdtdfundstablespoon of fixed income and all you need is a date for your formula to come to fruition and you are all set. The problem starts with the formula and ends with a prediction that is based on a model.

Started back in 1994, these funds languished as people felt empowered by an ever-increasing stock market to bet more aggressively on their own. By 1999, only $7 billion was invested in these kinds of funds marketed as lifestyle funds. Then the market tanked and the amount of people flocking to this safe haven tripled in size in just a few short years.

The 529 plan for college tuition saving, a sort of target-dated event in waiting, offered several different disciplines of investing depending on the age of your child. Aided by a favorable tax scenario, these funds had found a niche, albeit a short-term one. Parents would channle money into these funds and based on their child’s age, pick aggressive, moderate or conservative styles of investing. Those closest to college age would have their money stashed in fixed income and other securities deemed infallible. (We know now, in hindsight that some of those fixed income and infallible securities were in fact very vulnerable and tied directly to the housing market.)

This is when the funding in these funds began to grow. The next big push to the forefront of mainstream investment came with the Pension Protection Act of 2006. In it, Congress believed that target-dated funds might better than nothing as the default of their new push to get American workers involved in their own retirement future.

Even as the stock market tumbled (and continues to do so) investors are funneling money into these funds in the hopes of saving themselves. According to recent Wall Street Journal report, “the average target-date fund aimed at investors retiring in 2050 or later is down 44.2% over the past 12 months, according to Morningstar Inc., worse than the 43.3% decline posted by the Standard & Poor’s 500-stock index.” If not for those investors continued efforts at putting their money somewhere or selling what they view as a fail investment plan, the asset base for these funds would have fallen much more dramatically than it did. In fact, from the peak in mid-2008, the assets invested in these funds only lost only 21%.

This outsized enthusiasm doesn’t make this the better investment by any stretch. For two reasons: there is no empirical evidence that the fund managers leading these investments have any proof that their formula will work and secondly, if the losses in these funds exceeded a simple index investment, why are they still standing by their model for investment and more importantly, why are investors running to these funds?

Nothng can be more telling than the assessment made by Seth Masters, chief investment officer for the defined-contribution group at AllianceBernstein: “In the past year, [Alliance’s strategy] hasn’t worked well, but it doesn’t mean it’s wrong”. Really Mr. Masters, and what would convince you otherwise.

The inability for the average person to calculate long-term goals does not end at average. Fund managers can no longer make the same claim – if they ever could. These average investor, investment professionals contend, do a poor job of reallocating their stock holdings in their retirement accounts, often staying aggressive for far too long. That is, in their opinion.

This doesn’t mean that these professionals will be able to make good and well-timed decisions any better. What we have now is a case of past performance no longer being a selling point for a better idea, a more informative chart or a better constructed investment model. We all just as good as they are and because of that, we should be skeptical.

Train your skepticism first on the lure of target-dated funds. No one can make an accurate prediction and there is currently no model to instruct us on what to do next. That doesn’t mean that there isn’t a way. There is.

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