Life is like a Box of Chocolates - 4/13/13

In this week's edition:  Life is like a box of chocolates. . . Is this email not displaying correctly? View it in your browser.

Retirement Date Funds and Chocolate No doubt you've heard the maxim; "Life is like a box of chocolates…."  Interestingly this metaphor holds true with things that seem to promise what you are going to get in advance, like Target Date Funds.   Target Date (also known as Retirement Date and "Lifestyle" Funds) have grown in popularity - particularly in retirement plans.  The idea behind these "set it and forget it" funds is simple: Choose a year you plan to retire and then invest in a fund with the closest year - 2015, 2020, 2030 etc., –   The idea behind Target Date Funds is good: a comprehensive portfolio that becomes more conservative as retirement nears.  But the concept has been lost in the manufacturing process.  So lost, one reporter calls them "a dangerous rip off."  One reason for scrutiny is that with Target Date funds, like chocolates, "you never know what you're gonna' get."  But this is where the similarity ends.  With chocolates you usually wind up with something good either way.  Not so with these funds.  Dozens of fund families offer Target Date funds.  But differences in fees, allocation, and returns are staggering.  Tim Middleton of MSN Money reported in 2008 the Oppenheimer Transition 2010 fund lost 41.5% compared to 3.6% of another Target 2010 fund.  Of the problems inherent in Retirement Date Funds, arbitrary risk modeling is the most dangerous. "They (pre-retirees) got run over by a truck and didn't know why," said David Krasnow of Pension Advisors.  Investors generally conclude these funds take a protective stance – diversifying and decreasing potential losses over time.  This should create an appropriate investing "glidepath;" the same as a guidance system directing a landing plan would. Oddly, there has been no discussion, let alone consensus, let alone a standardized method for determining the glidepath for investors.  Some funds are aggressive while others are mostly cash by the retirement date.  Many find out which plane they are on when it crashes. So how does a good idea go awry?   Target Date Funds utilize a "fund of funds" design.  The Target Date fund "hosts" other mutual funds by investing in them to make up the portfolio.  The underlying funds have management fees and are often actively traded, incurring additional costs.  The host fund adds another layer of fees to manage often already expensive funds.  Manufacturers argue additional fees are deserved for managing the underlying funds.  I won't argue they don't have methods, but I note these methods are their own What they will be managing next year isn't knowable and the underlying funds are most often manufactured by the same company or by another with a fee sharing arrangement in place.  Read in what you will - but excessive fee complaints abound. Further, when employees invest in Target Date Funds, fund options offered by other providers in the plan are disregarded.  This creates the possibility the Target Date Fund manufacturer may corner the market in the plan, regardless of whether other options perform better or cost less. As an example, I recently looked at the retirement fund options offered by a very large company with over a hundred million dollars in its 401(k) plan.  It offered 27 investment options, 16 of which were target date funds.  While other options exist at in the plan at half the cost, they are predominately all U.S. large growth funds.  So if the employee wants to diversify at all, he has no choice but to put money in the Target Date Funds.  When I looked at the underlying holdings of those funds, they weren't significantly more diversified. And, according to academic standards, the majority of Target Date funds have this problem.  They weight toward large U.S. companies and intermediate bonds, scattering very small percentages across other asset classes. Historically, this approach has not significantly reduced relative risk or increased return.  These are the reasons we diversify in the first place.  MIT PhD Zvi Bodie states, "The damage is done by the inherently misleading name of the fund. They have nothing whatsoever to do with target dates. Nothing happens on the target date.  Nothing is promised on the target date.  So why call them target date?" Recently I showed a client how he would have previously boosted his return by over 2% per year by putting 50% in a broad stock market fund and 50% in a broad market bond fund instead of a balanced Target Date Fund – all of which were available in his retirement plan. He concluded, "It looks like they are double charging me for owning one fund instead of two."  To be fair there is more to it than that, just nothing of value to an investor.  What can I say?  It's a good gig if you can get it. I welcome your questions and comments. Warmly, Marc Becker For more insight on Target Date Funds: Stop the 401(k) Rip-off!: Eliminate Costly Hidden Fees to Improve Your Life http://www.thestreet.com/story/10389236/1/beware-excessive-fees-on-target-date-funds.html http://articles.moneycentral.msn.com/Investing/MutualFunds/target-date-funds-aim-elsewhere.aspx http://www.kiplinger.com/magazine/archives/2008/02/target_funds_under_fire.html http://www.iplanretirement.com/retirementblog/asset-allocation-a-dangerous-rip-off/ To read past articles and view past videos, visit: www.marcbecker.tv