Should You LEAVE your Money in a Target-Date Fund? “To” vs.”Through” Retirement Funds

Part 3: Target-Date Investing: Ten Investment Mistakes Wall Street Hopes You Make

” ‘Through’  funds have been concocted as (1) an excuse for the 2008 failure and (2) a grab at keeping assets longer.”
– Ron Surz, Target Date Solutions

If your money is in a Target-date fund in a 401(k), you’re already making some serious financial mistakes.

In our first installment of this series, we talked about:

• investment mistake #1: Giving up control of your money,
• mistake #2: Substituting target-date funds for financial advice, and
• mistake #3: Receiving “advice” from people with little-to-no training in retirement planning.

In part two, we explored:

• mistake #4: Trusting your investments to advisors and managers with conflicts of interest, and
• mistake #5: Paying substantial fees for the poor advice, sales pitches, conflicts of interest and mismanagement.

But I have a confession. It turns out, we soft-pedaled the impact of fees a bit. Yes, we demonstrated that fees will siphon off a whopping six figures from the average household’s retirement fund. But look how estimates of 30% or $155k lost to fees by age 65 continues to grow if you make the next mistake:

Mistake #6: Leave your retirement funds in a target-date mutual fund forever.

Historically, the great majority of investors typically remove their money from mutual funds upon retirement and put their nest egg into annuities, t-bills, or other investments considered safe. Now, Wall Street fund managers are now trying to re-educate the public that they should just leave their dollars in their target-date mutual funds for life. As a video on the Fidelity website says, their “Freedom Funds” are designed to help investors “achieve inflation-protected income through their retirement period.”

Another fund manager continues the explanation, “With the freedom funds… what we’re really trying to do is model someone’s entire investment horizon, with respect to retirement savings, the accumulation period, and the distribution period, and that can be up to 70 years: 40-45 years for accumulation, and 25-30 years for distribution.”

The problem with leaving your money in a target-date fund through retirement is three-fold:

First, your retirement funds are never safe from risk and loss. As the Fidelity talking heads explain, their glide path changes until the portfolio reaches its final, most conservative point “15 years after the target date.” Even then, safety or even a positive return are not assured, with equity positions in the stock market and commodities held long-term.

The video warns through fine print displayed in the last several seconds that “Principle invested is not guaranteed at any time, including at or after their target dates,” followed by a long list of market conditions that may cause financial loss and depreciation of underlying assets. Viewing this, it’s almost impossible not to think of pharmaceutical advertisements that name all the potential side effects – including death – as the fine print ends with this confession, “asset allocation does not ensure a profit or guarantee against loss.”

Perhaps even more disturbingly, it the “big three” (Fidelity, T. Rowe Price and Vanguard) had some of the worse losses in the 2008. And according to Target Date Solutions, “Nothing has changed…. The scandal isn’t 2008; it’s today.” The chart below from Target Date Solutions drives this point home:

The funds that sold the most, lost the most, and yet, when all the other retirement plans are offering TDF’s from “the big three,” it seems like a safe choice for plan administrators to “do what everyone else is doing,” whether it works or not.

Secondly, investors substantially increase the fees they pay when those fees are paid not just “to” retirement, but “through” retirement.

This is a great retirement strategy for money managers who profit from “assets under management,” but it might not be such a good deal for investors.

The Retirement Savings Drain report shocked investors by showing that 30% or more of their retirement savings were being paid out in fees. However, when Frontline talked to Vanguard founder John Bogle about investing for a lifetime – not just to 65 – his calculations were even more shocking:

“Let me give you a little longer-term example… an individual who is 20 years old today starting to accumulate for retirement. That person has about 45 years to go before retirement — 20 to 65 — and then, if you believe the actuarial tables, another 20 years to go…. So that’s 65 years of investing. If you invest $1,000 at the beginning of that time and earn 8 percent, that $1,000 will grow in that 65-year period to around $140,000.

Now, the financial system — the mutual fund system in this case — will take about two and a half percentage points out of that return, so you will have a gross return of 8 percent, a net return of 5.5 percent, and your $1,000 will grow to approximately $30,000… Think about that. That means… you, the investor in this long time period, an investment lifetime, put up 100 percent of the capital, took 100 percent of the risk, and got only a little bit over 20 percent of the return. That is a financial system that is failing investors…”

When a viewer challenged Frontline’s math, a benefits expert submitted a detailed table published by PBS to demonstrate how fees compounded “through” retirement to 85 did indeed “eat up a staggering 79 percent of what the investor would have earned with no management costs.” (However, the example is not representative of a retirement account, as money is not added nor are disbursements taken.)

While it may seem counter-intuitive that fees could eat up the majority of a investor’s profit, it is a legitimate mathematical phenomenon that Vanguard founder Bogle refers to as “the tyranny of compounding costs.” Costs, as well as profits, increase exponentially over time. And when target-date funds seek long-term control of investor assets, it can get very, very expensive.

Lastly, the historical returns of target-date funds have been dismal. Granted, it’s a short history for TDF’s, and we all know that past performance does not guarantee future results, but the funds are frankly just embarrassing themselves. It’s not just that they performed poorly while the market fell in 2008, as we explored in “Target-Date Funds: Wall Street’s Betrayal of Main Street Investors;” TDF’s have also done terribly while the S&P 500 has soared.

Hedging against themselves by diversifying into a meaningless mix, the funds perform like a car with the brake and accelerator on. In the market crash of 2008, funds targeted for a 2010 retirement lost an average of 23%. (Fund managers defended their substantial retirement fund losses before a Congressional inquiry as attempts to manage for “longevity risk,” an excuse to justify mismanagement and hold onto investor funds and keep collecting fees.) Since then, they have trailed the market significantly, often posting losses or staying flat as the market climbed.

And in the last year’s bull market? An August 13, U.S. News 2013 article predicts investors will be shocked when they see a loss for the last quarter and “year-to-date returns of between 2 percent and 6 percent while the S&P 500 has soared 18 percent.” Falling bonds and commodities almost cancelled out the stock market gains entirely.

“The problem is that the funds are really complicated,” says Todd Rosenbluth. Saddled by fees and “constrained by their overall investing rules,” TDF’s have demonstrated themselves completely unable to respond to market conditions appropriately.

It seems that fund managers have bitten off more than they can chew in their attempts to keep retirement funds safe while competing for growth that justifies the management fees. (After all, nobody is going to pay management fees for t-bills, so why not add stocks and commodities and call it “managing for longevity risk”?) While target-date funds purport to manage for both safety and growth, results show that they often fail on both fronts.

In an uncertain market, one guaranty that investors can bank on is this: if they leave their money in the 401(k) target-date funds through retirement, they stand to lose substantial money. They will either lose the money to the financial system through fees, or they will lose money to through fees and the market through the managers’ inability to protect the funds from risk, loss and underperformance.

So, where CAN money grow safely? Are there investments that won’t roller coaster like the stock market, or be eroded by inflation like bank CD’s? Are there safe investments that can bring double-digit gains (historically) without market risk? Are there vehicles that can generate income reliably with higher returns than bonds?

The answers are yes, yes, and yes! Contact us to set up a consultation with Kim D. H. Butler or one of our Prosperity Economic Advisors, we’d love to show you some true alternatives to target-date investing and the 401(k) failed experiment.