When Retirement Investors Hit The Panic Button: Financial Advisors' Daily Digest

by: SA For FAs

Summary

Ronald Surz critiques target date fund unethical practices.

Evan Powers: What March Madness can teach you about investing.

John Lohr: What is “the market” and what moves it?

It has become a cliché to question whether index fund investors will panic if the market tanks, placing enormous additional pressure on stock prices. With index fund assets now topping $6 trillion, that's a good question.

Ronald Surz asks another good question and less routine one - this time about the $1.5 trillion in target-date fund assets, which are growing extremely rapidly and are projected to reach $4 trillion by 2020. His question seems to be: Is the industry just going to continue to do nothing to lessen the risk of these funds before the next market crash occurs and investors lose their nest eggs?

I can already hear some readers challenging this, saying that nobody is forcing investors to sell. And that is true. Except sell they will. Many did in 2008 when TDF assets lost 30%.

Here again I can already hear the rebuttal: The market recovered those losses and went on to new all-time highs a little over one year later. True, but multitudes of panicked investors got off that market train in panic and thus did not benefit from that recovery.

As Surz writes:

It is…unconscionable for asset management companies to market TDFs under the wrong premise… that being performance over prudence. The intention of TDFs is to provide a safe path to retirement and not inject unneeded and potentially catastrophic risk particularly in the later stages of a participant's working life. It's not just good business or good investing… it is the cornerstone of the covenant every fiduciary has made with all participants."

What Surz is driving at is that these TDFs tend to hold a very high percentage of equities at the target date - in some cases as high as 75%, but most commonly at around the 55 to 60% level.

And here as well I can hear the rebuttal: With lengthy retirements, investors need to hold more in equities so that their portfolios will last for decades. That may be true. But even were we to accept this as the optimal approach in theory, we cannot ignore the reality that TDF investors who were generally defaulted into these investments through their corporate 401(k) plans are a) not the most sophisticated investors (hence, they're just going with the default option) and b) they are apt to assume that their retirement money is safe.

The general image of TDFs, which asset managers promote, is that the investments follow a glidepath from risky to safe at the time an investor reaches the target date. In that sense, Surz is making a fair charge that these products involve a degree of false advertising.

Main Street investors who watch their nest eggs wither, after assuming that that money was safe, are apt to push the panic button. Their doing so on the scale that their growing volume of assets represent will weigh down the portfolios of sophisticated investors as well.

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