Ah, target date funds were such a simple concept. Buy the fund for your projected retirement date and let the glide path guide you to a rosy retirement. It was the ultimate set-it-and-forget-it investment product. Who wouldn’t want that?
In practice, target date funds have run into all sorts of complicated hurdles.
1) Consumers didn’t know how to use the funds and so bought multiple target date funds in the same account, combined target date funds with a bunch of other active funds, or traded in and out of target date funds on a short-term basis.
2) The glide path turned out not to be fixed. Some investment committees tinkered with the asset allocations of the funds from time to time, so consumers were never completely sure what they were getting. The allocations also varied widely from provider to provider, based on different assumptions for returns, risk, and appropriate allocations for retirees.
3) When even 2010 target date funds took a beating in 2008, consumers discovered that the strategic asset allocation process embedded in the funds hadn’t done very much to protect their retirement assets. Almost universally, consumers expected the funds to be much more conservative when only two years from their retirement date.
4) The logic of allocating more and more to fixed income as the fund holder nears retirement is questionable. Yes, bonds are typically less volatile, but there’s no guarantee that will be the case. And piling more assets into bonds at today’s near-zero interest rates doesn’t necessarily seem like a clever idea.
And now this: it turns out that a substantial part of the fixed income allocation in some of the target date funds—and keep in mind that the fixed income allocation expands as retirement nears—is composed of low-rated, high-yield bonds. Probably not what the soon-to-be-retiree was expecting.
Frankly, some of these items are not the fault of the target date fund at all. There’s nothing wrong with high-yield debt as an asset class, for example. Consumers should do some due diligence and know what they are buying and how to use it properly. On the other hand, the marketing of the products sometimes gave the impression that everything would be handled for you.
Here’s a way to avoid most of these problems entirely: tactical asset allocation. Instead of assuming that it’s always good to own more bonds as you get older, how about investing on the merits of the individual asset? To me, the tactical approach just makes much more sense. Own stocks and other risky and higher-potential assets in environments when risk is being rewarded and switch to fixed income and other lower-risk assets in environments when risk is not being rewarded. Tactical asset allocation does require constant monitoring and adjustment, but it could turn out to be well worth it.
