Are 401k Investors Making a Mistake with Hybrid Funds?

I think this is an open question after reading some commentary by Bob Carey, the investment strategist for First Trust.  He wrote, in his 9/11/2012 observations:

  • Hybrid funds, which tend to be comprised primarily of domestic and foreign stocks and bonds, but can extend into such areas as commodities and REITs, saw their share of the pie rise from 15% in Q1’07 to 22% in Q1’12.
  • One of the more popular hybrid funds for investors in recent years has been target-date funds. These funds adjust their asset mix to achieve a specific objective by a set date, such as the start of one’s retirement.
  • In 2010, target-date fund assets accounted for 12.5% of all holdings in employer-sponsored defined-contribution retirement accounts. They are expected to account for 48% by 2020, according to Kiplinger.
  • Plans are shifting away from the more traditional balanced funds to target-date funds for their qualified default investment alternative (QDIA).

There’s a nice graphic to go along with it to illustrate his point about the growing market share of hybrid funds.

hybrid Are 401k Investors Making a Mistake with Hybrid Funds?

Are 401k Investors Making a Mistake?

Source: First Trust, Investment Company Institute  (click to enlarge)

He points out that 401k assets in hybrid funds are rising, but the growth area within the hybrid fund category has been target-date funds.  It troubles me that many 401k plans are moving their QDIA option from balanced funds to target-date funds.  QDIAs are designed to be capable of being an investor’s entire investment program, so the differences between them are significant.

There is a huge advantage that I think balanced funds have–much greater adaptability to a broader range of economic environments.  Balanced funds, particularly those with some exposure to alternative assets, are pretty adaptable.  The manager can move more toward fixed income in a deflationary environment and more toward equities (or alternative assets) in a strong economy or during a period of inflation.

Most target-date funds have a glide path that involves a heavier and heavier allocation to bonds as the investor ages.  While this might be worthwhile in terms of reducing volatility, it could be ruinous in terms of inflation protection.  Inflation is one of the worst possible environments for someone on a fixed income (i.e. someone living off the income from their retirement account).  Owning bonds just because you are older and not because it is the right thing to do given the market environment seems like quite a leap of faith to me.

Asset allocation decisions, whether strategic or tactical, should be investment decisions.

4 Responses to Are 401k Investors Making a Mistake with Hybrid Funds?

  1. [...] Why your target date fund may be doing it wrong.  (SmartMoney also Systematic Relative Strength) [...]

  2. [...] Are 401k Investors Making a Mistake with Hybrid Funds?  I’ve long thought target date funds were a ridiculous idea since it’s an active approach based entirely on your parents’ mating decisions and nothing to do with what’s going on in the market. [...]

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