Dear Mr. Market :
You certainly have a unique sense of humor! Your unpredictable personality often leaves investors scratching their heads as they attempt to figure out your next move and how they should be positioned. You’ve reintroduced us to market volatility the last few weeks and left investors scrambling. During the first quarter of this year, investors moved billions of dollars into the equity markets as they began to gain a sense of comfort based on recent performance. As investors muddle through the overwhelming amount of investment options available to them, more and more continue to look for the ‘quick fix’ or the ‘one stop shop’ and invest in Target Date Funds. By simply picking the fund that has a date corresponding to a time frame they have in mind for their investment goals, they can put their portfolio on cruise control and focus on more important things. Simple, right?
If only it were truly that easy…“If it seems to good to be true, it probably is”
Investors need to take a step back and not allow ‘Mr. Market’ to play with their hard earned dollars and take a look if these funds are in fact too good to be true. While the underlying premise of the fund appears sound, investors definitely need to kick the tires on these funds before buying them. The typical Target Fund intends to be much more aggressive in the early years and as the years pass and the ‘target date’ approaches, they will become more conservative. They do this through the asset allocation within the fund. Simply put, in the earlier years the portfolio has a higher percentage in stocks which then get trimmed with a reallocation and more exposure to fixed income or bonds.
Sounds perfect doesn’t it?!
In a perfect investing environment this strategy would be ideal but the harsh reality is we do not live in this world. In 2008, when the S&P 500 posted a return of -37%, every young and hard-working professional would be treated the same regardless of personal risk tolerance. Would this entire group want 90% of their money invested into something that lost almost 40% in just a few months? With 10 year treasuries currently paying less than 1.75% do you want a significant portion of your portfolio barely able to keep up with the fund’s management fees and historical inflation? Ask yourself if a high school senior going off to college and a baby boomer that’s about to retire should all be in the same bucket? Theoretically each of them would be almost all in Bonds and cash. Has anyone you’ve talked to recently mentioned the threat of inflation and rising interest rates? Would you be the first to hear that a potential “bond bubble” is coming? All that being said, how appropriate does that “conservative” and cookie cutter solution look to you now? While these funds certainly do have a place and fill a need, they’re primarily a marketing tool and a vehicle to attract more investors with a “one-stop solution”. Would it make sense for a doctor to put every patient over 45 years old that walks in his or her office on high blood pressure medication simply because it is common to prescribe it for people in that age group?
Target Date Funds can certainly have a place in an investor’s portfolio, but they should not be the only position in their portfolio. The average investor would not think it’s prudent to rebalance a portfolio every year or two based exclusively on an anniversary date or a new calendar year, however this is exactly what these funds do. Target Date funds also make broad assumptions that everyone within a certain age group has the same risk tolerance and goals for the investment they have within the fund. If this is not the solution then what is?
Investors need to realize who they truly are as investors. What is their risk tolerance, what are their goals and what makes them unique? It isn’t as easy as picking a date on the calendar years down the road when they hope to retire or go off to college! If investors are overwhelmed with these questions and have no desire to educate themselves, there are options available to them. There are many tools and services available online, or better yet… work with an ethical financial advisor (that is not commission based!).
Looking at your options and how to navigate through the markets reminds us of the famous childrens book by Dr. Seuss – Oh The Places You’ll Go! “You have brains in your head. You have feet in your shoes. You can steer yourself any direction you choose. You’re on your own. And you know what you know. And YOU are the one who’ll decide where to go…”
Don’t allow Mr. Market to play with your portfolio – take control and choose where and how YOU invest your funds. If we can be of any assistance or you have any questions please don’t hesitate to contact us or leave a comment. If you would like to subscribe for free to this blog please visit our home page.
Could I use a Target Date Fund to build a base within my 401k plan and then compliment that with other mutual funds that are available? I don’t want to have to monitor this daily or be too involved. The other issue is the options within my plan are not very impressive.
Thanks for the help!
DT – Thanks for the message! You certainly could use a Target Date Funds as your ‘base’ and then compliment it with either equity or fixed income funds depending on your risk tolerance and goals. There are some plans that will allow you to invest in other positions but this is different from plan to plan. If you would like to discuss in more detail please feel free to contact us directly – our contact information is listed under the ‘contact us’ tab.