by ETFguide | March 26, 2012 7:00 am
Target-date funds are being sold as the panacea for retirement savers. And 401(k) retirement plans are buying in.
Nearly 25% of 401(k) participants invest solely in target-date funds (TDFs), according to a new study by Vanguard Group. A major factor influencing the rise of TDFs is the automatic enrollment of participants into their 401(k) plan and the plan sponsors’ decision to choose target-date funds as the default investment option.
During the 2008-2009 financial crisis, many target-date funds blew up with the rest of the market. Why does nobody remember this? The mutual fund industry isn’t about to help them remember.
Target-date funds attempt to match a person’s age and risk tolerance with a projected retirement date. For example, the Vanguard Target Retirement 2050 Fund (NASDAQ:VFIFX) is aimed at people in their mid-20s, while the Vanguard Target Retirement 2035 Fund (NASDAQ:VTTHX) is designed for individuals in their 40s and the 2015 Fund (NASDAQ:VTXVX) is for people in their early 60s.
The year in the fund name refers to the approximate year (the target date) when an investor in the fund would retire and leave the workforce. Funds gradually shift their investment mix from more aggressive investments to more conservative as they approach their designated target date.
Despite their noble attempt to help people invest for retirement, TDFs have serious flaws that are being ignored or purposely hidden. Here are just a few:
1) TDFs encourage the public to be lazy about asset allocation.
The first choice for a retirement portfolio should be a customized mix that perfectly matches age, risk tolerance and goals rather than a canned, one-size-fits-all retirement fund that happens to be a default choice.
2) TDFs undermine the vital role of professional investment advice.
If the main purpose of a TDF is to help 401(k) savers to get the right asset mix, of what value are financial advisors who provide the same service?
3) TDF fees are still too high.
The average annual cost for TDFs is 0.62 percent, which is ridiculously inflated for the amount of work these types of mutual funds do. Talk about a wonderful profit center for mutual fund companies!
4) TDFs don’t properly tackle the issue of longevity — a serious problem that faces millions of retirees.
A TDF that switches the bulk of its allocation to iShares Barclays Aggregate Bond Fund (NYSEARCA:AGG) when a person reaches the standard retirement age range of 65-70 could subject these individuals to huge inflationary risks if they end up living an additional 20 to 30 years.
5) TDFs are not adequately diversified.
No matter what fund companies say, most TDFs are grossly under-diversified because they miss market exposure to major asset classes, including:
Various academic studies show that exposure only to stocks — e.g., Vanguard Total Stock Market ETF (NYSE:VTI) — bonds and cash is not true diversification. Anyone who says it is has a distorted perspective.
The bottom line: It’s true that a TDF default choice is better than nothing, but it’s not better than a customized investment mix that perfectly matches a 401(k) participant’s unique investment needs. Furthermore, the fees being charged by most TDFs are excessive, which will greatly reduces the retirement income of the people buying them.
Despite the so-called improvements to glide paths and other financial engineering to make them better, TDFs have simply increased their market exposure to bonds as a knee-jerk reaction to the stock-market clobbering they took in previous years.
No doubt, these very TDFs will take a beating when bond prices start faltering. In other words, TDFs are basically the same products they were a few years ago but with prettier packaging.
Source URL: http://investorplace.com/2012/03/5-major-flaws-of-target-date-retirement-funds-vfifx-vtthx-vtxvs-ag/
Short URL: http://invstplc.com/1dceoZ7
Copyright ©2016 InvestorPlace Media, LLC. All rights reserved. 700 Indian Springs Drive, Lancaster, PA 17601.