I see a lot of criticisms for Target Date Retirement Funds. Recently, I’ve seen a lot of commentary about how much money many of the funds have lost during the last year. If you’re near retirement, the last year has been particularly tough on you, no matter what asset class you’re invested in. There’s no safe haven. No one went unscathed.
The reason Target Date Retirement Funds got hit hard is obvious – they hold a lot of stocks. Of course, they hold different amounts of stock from year to year, but overall they tend to be heavily weighted in favor of stocks. This is a demonstration of the shift in investment philosophy that has occurred over the years.
I remember the first time I read The Intelligent Investor by Benjamin Graham. When he talks about the most aggressive portfolios in his day, Graham says that a very aggressive portfolio should be 75% stocks and 25% bonds. That was very aggressive back then. And that was only for the most enterprising of investors. The type of investors that do their own research, know how to read balance sheets, value assets and determine a fair value selling point for a stock (how many people do you know that can do this?). A more typical Graham portfolio might be 50% stocks and 50% bonds.
There was a clear reason for this. Graham was writing and studying investing during the Great Depression. The maxim that you hear all the time now – “rule number one is don’t lose money” (the alternatives are all positive) was borne out of a time when people had lost lots and lots of it in a short amount of time. Graham was focused on a defensive type of investing that minimized risk.
By contrast, when you talked to people about investing in the late 1990s, the general consensus was that people under 30 (incredibly, I’ve even heard some “gurus” say 40) didn’t need to own any bonds at all. The thinking was that over the historical long term, stocks outperformed bonds (still true). If you weren’t going to touch the money over 35 years, there’s a good chance that a portfolio filled with stocks will beat out a mixed portfolio.
One of the problems with stocks is you don’t know when a huge dip in the market will occur. It often takes stocks a long time to rebound to their previous levels from big crashes (recent market activity notwithstanding). It’s easy to feel like you have a large appetite for risk when stocks are moving upward. During the tech boom, for instance, everyone all of the sudden had this huge risk tolerance. Jim Cramer famously proclaimed in 2000 that internet companies “are the only ones worth owning now.” We all know what happened after that. It isn’t difficult to make Jim Cramer look silly (he does that on his own), but I think he has sort of epitomized the period of the recent bull markets and down falls.
In this same period, it was a period where people were complaining about their pensions and demanding they be offered some of the upside of the booming stock market. They didn’t want that downside though! How many people would trade their 401(k) for a pension today?
I honestly don’t think that Target Date Retirement Funds are a bad thing. I think they can be in some circumstances. I think you have to find a fund with very low fees. I would avoid anything that is actively managed and try to go for a fund full of index funds. Vanguard’s Target Date Funds, for instance, have a split of American stocks, International stocks and bonds in a mix of index funds.
Who are these funds right for? People who don’t want to mess with their investments. People who aren’t going to rebalance. Rebalancing has been shown to reduce risk and possibly increase returns. If your allocation is 75% stocks and 25% bonds, and stocks go down, you sell some bonds and buy more stock to bring your allocation back to what it was. This forces you to follow another old maxim, “buy low and sell high.” Best of luck. Thanks for reading.
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#1 by Daniel on November 11th, 2009 - 8:47 am
It’s a little to early for me to diversify, since I’ve been working less than a year and don’t have enough to hold multiple funds. I think target date funds are good for people who aren’t interested in or don’t have the skills to manage their retirement. All of the funds I’ve seen simply balance a percentages of other mutual funds. But I’ll always want to have a hand in doing it myself. I’m currently in a total stock market index and an international (junk) bonds fund (I love those monthly dividends).
And I’ve always though Jim Cramer was a tool. It makes me cringe to know my dad listens to him. I loved it when John Stewart slammed him on the Daily Show a few months back.
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