Anil Vazirani Scottsdale Investment Advisor shares Voices: Target-date funds are too risky for savers
One of the great financial innovations in recent decades is target date funds. These investment vehicles, which have $2.3 trillion in assets, are intended to be a sort of “set it and forget it” program for investors saving for retirement, automatically shifting one’s asset allocation from aggressive to conservative over time. This might not seem to be all that revolutionary. In the grand scheme of financial innovations, it’s actually a pretty simple idea, but studies show the vast majority of investors are terrible at allocating assets optimally on their own.
The thesis behind target date funds is that the investor outsources his or her asset allocation to a fund manager in exchange for an extra layer of fees that are typically not all that large. In doing so, the investor only has to pick one fund, taking all the brain damage out of investing and having to actively change the allocation between stocks and bonds as retirement approaches. Of course, there is the risk that the target date fund manager gets the asset allocation wrong, given generally accepted assumptions about future equity returns.
Bloomberg News
My criticism of target date funds is that they are uniformly too aggressive with their equity allocations. Most of them start out with about a 90% allocation to stocks in an investor’s early years, moving toward a 50% allocation as retirement nears. Having 90% of one’s money in stocks is too high in the beginning, and having 50% in stocks is too high at the end. These allocations are a function of the peculiar belief in that stocks are the best way to save for retirement. And even though stocks returned about 8% a year for the last 100 years, we have no knowledge of what they will return in the future, which argues for more diversification across asset classes.
The reason you’re not supposed to have such high allocations to equities is because volatility prods people to make stupid decisions. In a severe bear market, few people who will “hold on” and continue to dollar-cost average as stocks fall. Instead, they usually panic and liquidate their investments at the worst possible time. A target date fund that is predominantly in stocks will have the same effect on people.
Read More: https://www.financial-planning.com/articles/target-date-funds-are-too-risky-for-savers-jared-dillian
Anil Vazirani is president of Secured Financial Solutions, independent insurance advisor investment advisor rep with a fiduciary obligation and in the financial services industry since 1994. A+ rating with the Better Business Bureau for over a decade and a half, members in good standing with the National Association of Insurance and Financial Advisors.
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