The Target Date Tragedy

by: Cullen Roche

This article in Barron's over the weekend was pretty eye opening. They discuss the explosive growth of target date funds over the last 5 years.

Target date funds are a nifty little product. They give you a "target date" for your retirement and the allocation will change over time as you age. There's a few things I hate about this approach though:

  1. First, of all, these funds are implicit "buy and hold" portfolios that assume your financial life somehow has some start and stop date which means you could be substantially overly exposed to equities at points along the way. This means that a 30 or 40 year old investor could be exposed to an allocation of 70, 80 or 90% stocks during a year like 2008, which, no matter what your age is, can be extremely devastating for your financial planning purposes. Not to mention the fact that your quantifiable risk, also known as standard deviation, is being derived almost entirely from the equity portion of these portfolios. That means your 70% equity allocation is really more like a 80 or 90% allocation. In other words, these funds might be even more risky than many assume.
  2. Many of these funds (with the exception of the Vanguard funds primarily) charge about 0.75% for a buy and hold portfolio. This reminds me of what the Robo Advisors are doing. They're charging you a fee to "manage" a buy and hold portfolio. I just don't understand how anyone can justify a fee (above a near 0% index fund fee) for managing something so basic. Most of these Target Date funds aren't doing anything that a low fee index fund can't do, but the assets are trapped in these retirement plans and so the users of the accounts end up being forced to pay a whopping 0.75% per year for no good reason. That strikes me as extremely unfair when compared to alternatives.

Nothing's perfect in the investment world, but I do seriously question if some of these Target Date funds are the best way to go about servicing clients. I think as an industry we can do better for our clients. Vanguard is certainly on the right path. Other firms would be wise to follow their lead.