Criticism of Target Date Funds Is Misplaced

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.