Target date funds have received some criticism of late for being too aggressive. The funds, which adjust their allocations as a worker ages, lost money last quarter. Most are down year-to-date as well.
Here are three examples from our third-quarter Low Load Mutual Fund Update, which will soon be made available on our website to subscribers. Fidelity Freedom 2015 (FFVFX) lost 5.2% last quarter and is down 2.9% year-to-date (as of September 30, 2015). T. Rowe Price Retirement 2015 (TRRGX) lost 5.1% last quarter and is down 3.2% year-to-date. Vanguard Target Retirement 2015 (VTXVX) lost 3.9% last quarter and is down 2.6% year-to-date. The three funds, respectively, allocate 56.6%, 53.5% and 48.8% of their portfolios to domestic and international stocks. As the names suggest, they are designed for people who either have recently retired or are planning on retiring within the next two years.
None of these funds are taking excessive risk from an investing standpoint. Someone nearing retirement who is in fairly good health, blessed with good genes and at, or close to, retirement age could be looking at another 30 years or more of life. This type of potential lifespan requires either a large sum of current wealth or an ongoing significant allocation to equities to preserve the ability to buy goods and services. Life does not stop at retirement, and neither should a person’s or a target date fund’s investment horizon.
Those who want to roll up their sleeves and get into the nuances of the actual glide paths used by target date funds can make a different and far more valid argument. There is rightfully an ongoing discussion about how investors should adjust their portfolio allocations heading into and once in retirement. The traditional camp says to decrease exposure to stocks heading into and once in retirement (a downward glide path). A newer camp calls for decreasing exposure to stocks heading into retirement and then increasing equity allocations once in retirement (more of a U-shaped glide path). There are also those who suggest setting aside assets to cover expected expenses in retirement (via annuities, bond ladders, etc.) and then putting anything left over into risky assets. There are likely other schools of thought that don’t fit neatly into the descriptions of the first three camps. Target date funds follow the downward glide path with varying degrees of how and when they reduce equity exposure. Note that philosophies of the three primary camps will all be subject to criticism at some point in the future solely due to market fluctuations, the same way that target date funds are currently being criticized.
Target date funds are a big—if you will excuse the pun—target for criticism. They have published returns, known portfolios, manage large amounts of dollars and are the default investment option for many workplace retirement plans. They are also essentially one-size-fits-all products for investors in a specified age segment. By design, target date funds provide an age-based blanket allocation. They are a good choice for those who don’t know much about portfolio allocation or who simply don’t want the responsibility of making allocation decisions. These funds' largest shortcoming isn’t risk, but rather the simple fact that asset allocation is a very personal decision. A valid allocation strategy for one person can be a very bad allocation strategy for someone else of the very same age. Anytime an off-the-shelf investment product is used, compromises will exist.
A Few Words About Ben Bernanke
Former Federal Reserve chairman Ben Bernanke was in Chicago on Tuesday to promote his new book, “The Courage to Act: A Memoir of a Crisis and Its Aftermath” (W.W. Norton & Company, 2015). He spoke with Martin Wolf (The Financial Times’ chief economics commentator) for about an hour. While I won’t rehash the entire conversation, I will share a few things I think will be of interest.
As would be expected, Bernanke defended the monetary policy actions taken during his tenure. In discussing the financial crisis, he said the Federal Reserve knew that housing prices were high and that subprime credit was a problem, but he and his colleagues didn’t realize how dependent the financial industry was on short-term financing. Bernanke added that since that since the crisis, the Federal Reserve now does worst-case scenario analysis instead of trying to identify bubbles.
He is cognizant of the impact that low interest rates has had on those dependent on portfolio income, saying “I sympathize with savers.” Bernanke rationalized, however, that if interest rates had been raised prematurely, the economic recovery would have been jeopardized. He also blamed fiscal policy, saying the Federal Reserve had to be aggressive in trying to spur growth because of the lack of assistance from the federal government and state governments.
During the question and answer session, Bernanke was asked where the current financial risks are. He said they are mostly in emerging markets. Falling oil and energy prices, decreasing demand from China for imported goods and materials, and the stronger dollar are all creating problems for emerging market countries. The stronger dollar is particularly problematic for emerging market companies that took out dollar-denominated loans and now face the prospect of having to make debt payments with local currencies that are now comparatively weaker against the U.S. dollar.
- Target Date Funds: A Simple Premise, but Underlying Complexities – This 2012 AAII Journal article gives an in-depth look at target date funds and how their allocations evolve over time.
- Determining Your Allocation at Retirement – Even among those who advocate a downward glide path, differences of opinion on what to do at and after retirement exist.
- Should Target Date Funds Focus on Risk or Growth? – Share your opinion on the AAII.com Discussion Boards.
The Model Fund Portfolio declined by 4.0% in September, while the Model Shadow Stock Portfolio, which invests in micro-cap value stocks, was down 6.8%. Fortunately, the market has bounced back from its low, which was hit on September 29, 2015.
The Model Shadow Stock portfolio only had seven out of 30 stocks up for the month. SigmaTron International (SGMA) and Marlin Business Services (MRLN) were the strongest performers, with double-digit gains for the month. Year-to-date the Model Shadow Stock Portfolio has declined 15.5%, while the Vanguard Small Cap Index fund is down 6.7% and the DFA U.S. Micro Cap Index fund is down 7.0%. Since its inception in 1993, the Model Shadow Stock Portfolio has a compound annual average return of 15.6%, while the Vanguard 500 Index fund (VFINX) has gained 8.7%.
The Model Fund Portfolio’s 4.0% decline in September compares to a 2.5% decrease for the Vanguard S&P 500 Index fund. Since its inception in June of 2003, the Model Fund Portfolio has a compound annual average return of 7.9%, just ahead of the 7.8% return of VFINX over the same time period.
There are no changes to the Model Shadow Stock Portfolio or the Model Fund Portfolio this month. The Model Fund Portfolio will be discussed in the November 2015 AAII Journal.
AAII President John Bajkowski will speak to our Boston Chapter on Thursday, October 22.
More than 110 members of the S&P 500 will report earnings next week. Included in this group will be several Dow Jones industrial average components: International Business Machines Corp. (IBM) on Monday; Travelers Companies (TRV), United Technologies Corp. (UTX) and Verizon Communications (VZ) on Tuesday; American Express Company (AXP) and Boeing Co. (BA) on Wednesday; 3M Co. (MMM) Caterpillar (CAT), Microsoft Corp. (MSFT) and McDonald's Corp. (MCD) on Thursday; and Procter & Gamble Co. (PG) on Friday.
The first economic report of note will be the National Association of Home Builders’ October housing market index, released on Monday. Tuesday will feature September housing starts and building permits. September existing home sales will be released on Thursday. The PMI’s October manufacturing flash index will be released on Friday.
Richmond Federal Reserve bank president Jeffrey Lacker will speak on Monday.
The Treasury Department will auction $7 billion of 30-year inflation-adjusted securities (TIPS) on Thursday.
- Five Key Financial Concepts
- 16 Financial Ratios for Analyzing a Company’s Strengths and Weaknesses
- Calculating Intrinsic Value With the Dividend Growth Model
Pessimism among individual investors fell to a three-month low in the latest AAII Sentiment Survey. Optimism declined as well, while neutral sentiment rose.
Bullish sentiment, expectations that stock prices will rise over the next six months, pulled back by 3.4 percentage points to 34.1%. The decline follows last week’s reading of 37.5%, which was the highest level of optimism recorded by our survey since March 26, 2015. The decline also puts bullish sentiment below its historical average of 39.0% for a record 32nd consecutive week.
Neutral sentiment, expectations that stock prices will stay essentially unchanged over the next six months, rose 4.5 percentage points to 38.8%. The increase keeps neutral sentiment above its historical average of 31.0% for the fifth consecutive week and the 39th week this year.
Bearish sentiment, expectations that stock prices will fall over the next six months, declined 1.0 percentage points to 27.1%. The historical average is 30.0%.
Pessimism is now at its lowest level since July 23, 2015 (25.6%). Since jumping to 39.9% two weeks ago, bearish sentiment has fallen by a cumulative 12.8 percentage points. The drop comes as the S&P 500 has rebounded from its late-September lows and recently closed at its highest level since August 20, 2015.
Even though there is optimism on the part of some individual investors that a bottom in the market has been set, sentiment overall remains mixed. Some AAII members bought on the dips while others increased their cash positions. Impacting AAII members’ six-month outlook for stocks are global and international events (particularly China and global economic weakness), U.S. monetary policy, technical factors (seasonal trends, the recent correction or the chance of further price declines occurring), U.S. politics and the pace of U.S. economic growth.
This week’s special question asked AAII members for their opinion of the current pace of economic growth. About one out every five respondents (21%) expressed disappointment or frustration, using words such as anemic, sluggish, lackluster and poor. Nearly 17% said growth is slow. An additional 13% said economic growth is either very slow or essentially stagnant. About 7% said growth is either at an acceptable or adequate level, particularly given the ongoing headwinds.
Here is a sampling of the responses:
- "I think growth is slow because there is still a lot of unemployment. Also, there is a lot of turmoil in the world.”
- "It has been an anemic recovery.”
- "Too slow, and could be much better with better fiscal policy in Washington.”
- "As good as can be expected considering global conditions.”
- "I expect slow growth to continue in the United States.”
- "Slow, but steady. Could be better, could be a lot worse.”
Bullish: 34.1%, down 3.4 points
Neutral: 38.8%, up 4.5 points
Bearish: 27.1%, down 1.0 points
Bullish: 39.0%
Neutral: 31.0%
Bearish: 30.0%
Local Chapter Meetings
October 8, 2015 A Major Rule Change for Mutual Funds and ETFs
October 1, 2015 Notes From the Morningstar ETF Conference
September 24, 2015 Keeping Your Accounts From Being Lost to State Governments
September 17, 2015 Three Ways to Move Money Into a Roth IRA
