This is the title of an article in the weekend edition of the Wall Street Journal that discusses some of the problems of target date funds.
Target date funds are an increasingly popular option for retirement plans. Investors like the idea that everything will be handled for them-yet often they are not aware of what is actually being done within the fund. The overarching problem is that the funds rely on strategic asset allocation and predictably push the portfolio toward bonds as the investor nears retirement. Using strategic asset allocation rather than tactical asset allocation is a dubious premise to begin with, something we wrote about back in 2009. Now we have company from the Wall Street Journal, which weighed in with this:
The market rout of 2008 was tough on so-called target-date mutual funds. Designed to protect investors by decreasing their exposure to stocks and increasing their bond holdings as people get closer to retirement, the funds performed much worse than expected during the financial crisis.
Many funds have responded by ramping up their holdings of seemingly safe bonds. The problem? Some experts now worry that the bond market is headed for trouble.
The move to safety, in other words, could end up putting investors at more risk.
Duh. The reality is that no strategic asset allocation can possibly be appropriate for every investment environment. Tactical asset allocation explicitly recognizes this and makes allowance for adjusting allocations as conditions change.
The article also points out that some of the recent changes in bond allocations appear to have been reactive. In other words, since the funds got clocked in 2008, they subsequently increased their bond allocations to avoid a similar situation. Maybe their ploy will work—no one knows the future. On the other hand, it’s rarely a good idea to shut the barn door after the horse is gone. Usually it just exposes you to a different risk than the one that caused the problem earlier.
For example, if your bond allocations were increased post-2008, it would simply mean that you had a smaller allocation to equities. The big winner over the last two years? Stocks.
Here’s a way to avoid the problens of strategic asset allocation 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.
