Both Consumer Reports and The Wall Street Journal have recently reported target-date funds (TDFs) continued to underperform in 2011. Moreover, when parsing the data from 2011, it looks like TDF portfolio managers ignored the lessons of 2008. Once again, TDFs with near-term or expired targets (i.e., 2010) lost money when the markets tanked in the third quarter. Although many advisers, as cited in "401k Plan Sponsor Concern: Target Date Funds Still Broke," (FiduciaryNews, January 10, 2012), question when TDFs will finally get their act together, they're not ready to throw in the towel on them yet.
Let's take a look at the success and failure of TDFs. When the DOL included them on the list of default funds in 2006, not many people had heard of TDFs. They knew of Lifestyle Funds and Balanced Funds (also placed on the list), but TDFs were relatively new creatures. Not much was known about them, and that included their underlying fees, their underlying investments as well as not even a whiff of a track record. Still, the industry saw a way to increase margins and investors bought the "set-it-and-forget-it" sales pitch of TDFs with a vengeance.
OK, so there's some good news and some bad news in the mass migration to TDFs. First, the good news. The purpose of this particular portion of the Pension Protection Act of 2006 was meant to: a) increase the number of employees participating in their 401k plan; and, b) shift the asset allocation away from stable value vehicles to equities. TDFs certainly played an important role in attaining success in both of these objectives.
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But for every yin there's a yang. It turns out TDFs haven't lived up to their billing from an investment vantage point. Sure they floated up with everything else following the nadir of March 2009. That was expected. What wasn't expected, however, was their response to the return of madness in the third quarter of 2011. Then, as the markets seemed to desperately seek a repeat of 2008, we found TDFs suffered the same fate as they had three years earlier. In most cases, according to Consumer Reports, investors would have been better off in a balanced portfolio of index funds – this despite the fact many TDFs consist of index funds!
There are some who are beginning to wonder if the whole premise of TDFs may have been misconstructed. TDFs assume investors buy and hold the same TDF throughout their lifetime. In the real world, as recommended with good reason by many financial professionals, employees often roll their assets out of the employer's retirement plan once they leave the company. This not only saves them the administrative costs associated with an ERISA plan, but it also makes it easier for them to pay a personal adviser for personal advice.
So, is it time to send TDFs to the showers? Maybe not, but they do have two strike against them. One more and, who knows, maybe all those new (since 2006) investors might just decide it better to spend today's earnings on instant gratification than wallow away the years watching TDFs continuing to disappoint.
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Christopher Carosa
Chris Carosa has been writing a weekly article and monthly column for BenefitsPRO online and BenefitsPRO Magazine since 2011 and is a nationally recognized award-winning writer, researcher and speaker. He’s written seven books, including From Cradle to Retire: The Child IRA; Hey! What’s My Number? – How to Increase the Odds You Will Retire in Comfort; A Pizza The Action: Everything I Ever Learned About Business I Learned By Working in a Pizza Stand at the Erie County Fair; and the widely acclaimed 401(k) Fiduciary Solutions. Carosa is also Chief Contributing Editor of the authoritative trade journal FiduciaryNews.com and publisher of the Mendon-Honeoye Falls-Lima Sentinel, a weekly community newspaper he founded in 1989. Currently serving as President of the National Society of Newspaper Columnists and with more than 1,000 articles published in various publications, he appears regularly in the national media. A “parallel” entrepreneur, he actively runs a handful of businesses, including a small boutique investment adviser, providing hands-on experience for his writing. A trained astrophysicist, he also holds an MBA and has been designated a Certified Trust and Financial Advisor. Share your thoughts and story ideas with him through Facebook (https://www.facebook.com/christophercarosa/)and Twitter (https://twitter.com/ChrisCarosa).
