“Target-date funds… are the lazy investors dream.”
-The “Buy Like Buffet” blog
If you’ve been following our blog, you’re aware that we’re not big fans of target-date funds.They have suffered from poor market performance, higher-than-necessary fees, and other substantial problems for investors, such as conflicts of interest and risky management of funds nearing or at retirement.
But in spite of these issues, target-date funds are the fastest-growing type of mutual fund in 401(k)s today, holding more than half a trillion dollars. According to Vanguard, the number of its 401(k) participants that invest solely in target-date funds has exploded recently, increasing six-fold over the past five years.
The very fact of their growth is a clue to what is very, very RIGHT about target-date funds: their notably positive influence on investor behavior. Indeed, they have been engineered specifically for this exact purpose: to be attractive to the average/ newbie/ unsophisticated investor. And whether or not TDFs make an ideal or even an acceptable investing vehicle, when people start saving, it’s a good thing.
Retirement is an improbability for most Americans, especially considering that 49% of Americans aren’t saving ANYTHING in a retirement plan, according to Money.CNN.com. And yet, a recent poll by Credit.com found that the goal of retiring financially secure at 65 has actually replaced home ownership as the American Dream. (Home ownership took third sadly, behind getting out of debt.)
Thanks to the perception and marketing of target-date funds as a “one-step” retirement solution, combined with the Department of Labor’s blessing of them, (employers who make target-date funds the “default” option for their company 401(k)s are granted “safe harbor” from legal action if the investments lose money), many investors have-
- Overcome indecision over fund choices and procrastination and actually started investing.
- Developed a habit of saving consistently. (Even when funds have taken losses, investors have stuck with them.)
- Adopted a long-range attitude towards investing, which target-date fund names help to foster. (Fund names include the target retirement year, such as “Freedom 2050 Fund.”)
- Recognized that the stock market alone might be an inadequate place for all of their investments. (We think that target date funds still put MUCH too much equity in the stock market, but agree that 65 or 85% is an improvement over 100%.)
- Decided not to rely on Social Security alone to take care of their future financial needs.
Target-date funds are especially popular with young investors, who are otherwise the least likely to be active investors. TDFs represent a whopping 31.3% of defined contribution assets of 20-somethings, as this chart from the 2013 Investment Company Fact Book from the Investment Company Institute demonstrates:
The yellow represents the percentage of defined-contribution funds invested by 20-year-olds into target-date funds, barely second only to stocks and mutual funds in general. In contrast, only 11% of defined contribution assets of participants in their 60′s were invested in TDFs.
The success of TDFs highlights an important fact: many Americans feel intimidated by investing. They know they “should” do it, but they get bogged down trying to make initial decisions about where and how to invest. They want professional advice and guidance, but aren’t motivated (or able) to pay for individual financial advice. Afraid to make mistakes and do the wrong thing, people often do nothing at all.
With TDFs, investors are following a path that many others are following, which seems to confirm their choice. Investors also like to think a professional money manager is looking out for their investments. (Even when those managers are raising risks in attempts to chase growth, most TDF investors remain blissfully unaware.) And they don’t want to have to worry about re-allocating assets every few years, so they love thinking that they can “check” retirement planning off their list with by checking a TDF fund choice on their 401(k) and/or IRA paperwork.
But most of all, many investors want investing to be EASY, and they need it to be automatic. Especially on these final matters, target-date funds hit a home run.
According to Steve Utkus, director of Vanguard Group’s Center for Retirement Research, investors like target-date funds because they are “easy.” Investors “don’t have to worry about creating (their) own mix of investments… (they’re) buying a simple way to invest,” he told the WSJ.com.
Target-date funds also help to eliminate or reduce other major investor mistakes in addition to procrastination. According to a 2010 SEC report on “Behavioral Patterns and Pitfalls of U.S. Investors,”other major investor mistakes include:
- trading frequently (the more active a trader is, the more they tend to underperform the market),
- familiarity bias (which can keep investors under-diversified, perhaps most dangerously, in their own company’s stock), and
- the disposition effect, which is the tendency of investors to sell winning positions and to hold onto losing positions.
The positive effect on investor behavior should not be under-estimated. If investors develop the HABIT of saving/investing consistently, and if they develop that habit EARLY in life, then they have conquered one of the biggest challenges to investment success: themselves. Creating wealth is not possible when procrastination, inconsistency, lack of discipline, and other counter-productive behaviors sabotage success.
In a country in which one in three Americans have no retirement savings at all, any tool that influences people to start saving is useful. Once investors develop a healthy and consistent savings HABIT, they can switch to other strategies. In contrast, it is more difficult to convince an employee that is used to spending 100%+ of their paycheck to change their ways and develop a disciplined savings habit.
So… Are Target-Date Funds a Good Investment Solution?
Due to shortcomings in performance, safety, management, fee structure, investment philosophy and more, we do NOT recommend target-date funds. We believe they are quite problematic, in spite of their positive effect on investor behavior. However, TDFs challenge us to recognize that many investors want and need an EASY, simple answer to the question: “Where can I put my money where it will grow safely?”
As policy analyst Robert Hiltonsmith lamented on the excellent Frontline special, The Retirement Gamble,
“We need something different out there. We need something simpler, something safer, you know, honestly, something that people can put their money in, get good returns, not have to worry about losing their entire nest egg, and then trust that they’ll actually be able to retire one day if they… do the right thing and save enough.”
We couldn’t agree more, which is why we recommend that people utilize a century-old, rock-solid financial industry - whole-life insurance. If you’re not sure where to start saving, this is the perfect first step. Why?
- Liquidity. The money can be used or borrowed against at will without the need to qualify or wait until a certain age, which makes it useful as an emergency fund.
- Guaranteed minimums. Cash value gains are locked in and immune from market crashes. We have found that steady growth motivates people to save!
- Competitive. Rates of return, though modest, are guaranteed above the current inflation rate and above gains for treasury securities, bank CDs and other investments generally recognized as “safe.” (Rate of return varies by age, contact us for specifics.)
- Rock-solid. Mutual life insurance companies have a stellar history of paying dividends without fail (even during the Great Depression, as well as the recent Great Recession).
- Tax-advantaged. Unlike funds in a traditional IRA or 401(k), cash value gains are not subject to income taxes.
- Protection. A properly set-up whole life policy guarantees steady increases in both death benefit and cash value, offering policyholders protection, stability, and security for their family. (The death benefit is in addition to the cash value.)
- Flexibility. The ability to collateralize cash value while it earns dividends offers policyholders increased options for major purchases and even other investment opportunities.
- Easy. It’s SIMPLE and SAFE, with no need to study the stock market or re-allocate funds every year.
Investing additionally in your company 401(k) may make sense if your employer offers a match, but be aware that you’re signing up to pay a lot of fees and future taxes as well as taking on market risk, in most cases. There are other options that make more sense for most investors, so we don’t recommend putting too many eggs in the mutual fund basket (and especially NOT in target-date funds.)
Are You Still Investing in a Target-Date Fund?
We’d love to show you other options that can turn your consistent, reliable savings habits into consistent, reliable returns. There are other choices that won’t put your savings at the mercy of the stock/bond market unpredictabilities. Depending on whether or not you qualify as a suitable or accredited investor, different options are available.