PART 4 of our “Target-Date Investing: Ten Investment Mistakes Wall Street Hopes you Make” series.
“In my opinion, they (target-date funds) should come with a label that says, ‘Warning: This target-date fund is loaded with equities that may be hazardous to your retirement plans.’ “
-Brian Graff, CEO of the American Society of Pension Professionals & Actuaries, in Bankrate.com article
Are you really diversifying and reducing risk with a TDF? As we explore mistakes #7 and #8 today, the truth might sting!
In part one of this series we revealed the first three mistakes:
- Giving up control of your money,
- Substituting target-date funds for financial advice, and
- Receiving “advice” from people with little-to-no training in retirement planning.
In part two, we named the next mistakes Wall Street hopes you make:
- Trusting your investments to advisors and managers with conflicts of interest, and
- Paying substantial fees for the poor advice, sales pitches, conflicts of interest and mismanagement.
And in part 3, we explored in depth the sixth mistake:
- Leaving your retirement funds in a target-date fund after retirement.
What other mistakes are you making if your money is in a target-date fund? This week, we look at two places that TDF’s fall short: diversification and risk reduction.
Mistake #7: Fail to truly diversify. Let your target-date fund do that for you.
Too many investors stick to the limited mutual funds offered through their 401(k), not even attempting to learn about the options beyond their 401(k) options, and (most importantly), options apart from mutual funds. Sadly, these limited options lead many investors to mistakenly assume that there are no meaningful alternatives outside of the stock market.
Why does this matter? There’s a whole world of investment and income options outside of stocks, bonds, and mutual funds, including investments that are not sensitive to wall street crashes and interest rate changes. Historically, we’ve seen the stock market lose upwards of 20%, 30%, even 50% in a single year. Bonds, traditionally used to balance stocks and protect against losses, are also vulnerable to loss, as are banks (particularly in the current environment, according to Peter Schiff, a controversial commentator who predicted the 2008-2009 subprime debacle.)
A mutual fund salesperson will talk about “diversification” as having a mutual fund portfolio that contains large cap, small cap, domestic and international funds in different industries. But while mutual funds protect against isolated vulnerabilities of individual companies going belly up, it does little to protect an investor when the entire market tanks. Diversification within mutual funds is, largely, an illusion.
In target-date funds, stocks are “balanced” with other assets that are also vulnerable to loss, such as bonds, commodities, and other types of assets, all sold by financial corporations, all subject to typical fees and commissions. Wall Street will only sell you other Wall Street products to help you “diversify,” which ultimately leaves you vulnerable. The bottom line? If you want to truly “diversify,” you must diversify with investments OUTSIDE of mutual funds.
What does it mean to be diversified?
Robert Kiyosaki once described a diversified portfolio as being balanced between investment real estate, private business investments, and “paper” investments such as stocks and bonds. Some target-date funds point to REIT’s as their “real estate” diversification, but REIT’s are not the equivalent of actually owning rental property. As a Motley Fool article explains, “The biggest negative to REIT investing is the value of REIT shares often follow the trend of the rest of the stock market. This tends to somewhat negate the diversification benefits of investing in real estate.” REIT’s are also taxed like mutual funds, laden with management fees, and offer investors no control over the physical properties.
In other words, target-date funds are no substitution for owning real estate. Neither are target-date funds a substitution for ownership of a business. (These days, the stock market has less to do with investing in businesses and more to do with speculation of prices.) And target-date funds are also no substitution for participating in the benefits what may be the most solid financial industry of the last century and beyond – mutual life insurance companies.
Many smart investors have significant liquid assets such as whole life cash value funds which can be borrowed against for emergencies, opportunities, and major purchases. The modest but reliable returns, flexibility, dividends, and tax advantages make cash value accounts an ideal place to store money. Additionally, the death benefit allows investors the freedom to spend down other assets and still leave money to heirs. (White paper on this strategy coming next week.)
But Wall Street hopes you won’t give up on gambling with your retirement just yet….
Mistake #8: Compensate for a lack of savings by adding risk.
Wall Street hopes you are making this mistake because, otherwise, you would lose interest in paying fees to an industry that keeps your money at risk! And ironically, the target-date fund managers are making this same mistake – even though it’s one of the main mistakes that target-date funds were supposed to be the remedy for!
As Robert Boslego, managing director of Boslego Risk Services asserts in a guest column for Riabiz.com in which he explains the failure of target-date funds to protect investors from loss, “There is no guarantee that stocks will recover from a major loss within the time frame the retirement money is needed. [An investor] may literally die waiting for his or her portfolio to recover.”
When the SEC and Congress held an inquiry to determine what went wrong with target-date funds in 2008, when TDFs targeting 2010 retirement dates lost an average of 23.5% revealed, the mutual fund industry defended their risk-taking by saying they were “managing for longevity risk.” (The old “I meant to do that” explanation…) That defense was used to justify high percentages of stock market equity in retirement funds nearing their target dates, junk bonds, even derivatives.
By even admitting they were managing for “longevity risk” instead of asset preservation, the mutual fund industry revealed that TDF’s are risky and inappropriate vehicles for anyone who has saved diligently.
But have target-date fund managers changed their ways? Absolutely not. “The Scandal isn’t 2008. It’s today,” says Target Date Solutions, asserting that “nothing has changed” to correct the losses of 2008.
As we discussed in more detail in “Target-Date Funds: Wall Street’s Betrayal of Main Street Investors,” target-date funds purport to be an all-purpose investment solution that can manage for safety as well as growth, but fund managers have abandoned their responsibility to preserve retirement funds even past retirement target dates in their race to compete for short-term gains and market share.
The truth is that you can’t solve a savings problem with an investment solution. Adding risk is not the answer, any more than a trip to Vegas is likely to help an investor who has only saved a fraction of what they need to retire.
The bottom line? We find that savers and investors are motivated to save and invest when their money is safe, and when returns are predictable. And that doesn’t mean settling for rock-bottom bank CD rates! But it does mean opting out of Wall Street “solutions” like target-date funds.
Does your money belong in mutual funds and stocks at all – target-date funds or otherwise?
With the rise of high-frequency speed trading, derivatives, and Wall Street volatility, many savvy investors (including billionaires) are opting out of the stock market altogether. They have discovered better and more consistent returns by investing in alternative investment vehicles such as life settlements, investment real estate, business (through traditional means and partnerships, or even peer lending platforms), tax lien certificates, or private loans secured by real estate. Even whole life insurance (more of a place to store cash than an investment vehicle), can be a better alternative to the market roller coaster.
We think there is a better way. Here at Partners for Prosperity, Inc., we call this way “Prosperity Economics.“ Target-date funds do a better job creating wealth for brokers and fund managers than investors, but Prosperity Economics offers a true alternative to “typical financial planning.”
There are ways to reduce and eliminate risk, give fewer dollars to Uncle Sam and financial CEO’s, and grow money safely with healthy, reliable returns. We invite our readers to explore the Prosperity Economics Solution. A great place to start is our founder Kim Butler’s recent book, Busting the Financial Planning Lies.