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The Risks of TDFs

July 28th, 2010 at 08:31 am

I was reading this article, The Risks of Target-Date Funds, and thought it would be worth writing about. I'm going to assume that readers already know what they are (which also goes under the name of Freedom funds, Lifecycle funds and Target Retirement funds).

First, I just want to say that I am a big fan of them. They are particularly good for average, passive investors looking for a way to "set it and forget it" for their retirement investments. In fact, my entire 401(k) is just one of these funds right now.

That said, nothing in life is without risk, and these funds are no exception. The article linked here is one such reminder of that.

The only thing I would say about the article is that they're pointing out the end of 2008 as an example of how TDFs have failed investors who were nearing retirement by having too much % equity. To which, I do have some rebuttals:

1. Retirement investing does not end at retirement. Hopefully, you'll still have 30 more good years ahead of you, so even if you have taken a hit back in 2008, there is still time to recover and grow even more.

2. Even 100% fixed income investments comes with its own risk, such as inflation risk and longevity risk. Suitability of asset allocation depends on the size of your nest egg and risk tolerance.

3. Prior to 2008, most of these TDFs were criticized for being too conservative and not matching the gains from more aggressive funds. This was an incorrect perception back then, as the point isn't so much to increase gain, but more to decrease risk in my opinion. But it's hard to be reminded of risks during the good times. Not surprisingly, more aggressive funds fell out of favor after 2008, but TDFs also took a hit for being too aggressive as well.

4. After 2008, most target funds (or at least Vanguard funds that I am aware of) have been tweaked to become more conservative. So, it's important to keep in mind that today's 5-year horizon TDFs is not the same as the pre-2008 5-year horizon TDFs for example.

But regardless of the details in this debate, I nevertheless agree that we should always be ever-vigilant of our money. In the era of Toyota and Honda safety recalls, even the best can falter, and it's up to us to be aware of these issues.

10 Responses to “The Risks of TDFs”

  1. MonkeyMama Says:

    I like TDF funds, but aware of all this, I look at the stock/bond mix I want now, and pick my TDFs based on this. With age, I may go more conservative, or more aggressive by picking other years. In the interim, they are getting tweaked every 5 minutes (as you mentioned - too conervative, too aggressive, back and forth).

    I actually have my kids in TDF (Retirement date) funds. I don't remember the date I picked, off the top of my head. College is a different animal, and I may put it all in cash once they are 18. Not saying I will, but I just found the TDF to be a good vehicle until I get to the "5-year horizon," when I will take a much more hands on approach. In the interim, I keep an eye on the underlying funds.

  2. baselle Says:

    I'm very mixed about TDFs, because they really tend to reflect fads in risk perception rather than investing. They are marketed to the clueless, when one actually needs a lot of clues to benefit from them. Very eye opening to take a ticker symbol of one of the TDFs, put it into Morningstar and see what pops up.

    But then again, I'm a "if this investment goes into the ditch, I want both hands on the wheel as its going down" kind of investment gal.

  3. Rick Says:

    I like the idea of the target funds, but have not been impressed with the returns or asset alocation.

  4. Broken Arrow Says:

    Great comments so far!

    Baselle, I'm with you. I too think that TDFs tend to be mediocre and one can indeed do better.

    On the other hand, it does require someone who has both the interest and the knowledge to know what is "better" and how to achieve it.

    Like it or not, there will always people who really do not want to have anything to do with investing other than, "well, I guess this is something I have to do." To them, it's like a root canal, and they would rather be doing almost anything else. For those, TDFs are a great option.

    But then, I also use them in one of my passive accounts as well. I don't think they're not bad either, if you're looking for a hands-off approach....

  5. LittleGopher Says:

    I agree with all that you're saying, and we too have my husband's 401k in a target fund for the very reason of not having time to research the other offerings.

    We recently received a mailing from his company stating that they're offering a professional account manager program service (1st 3 months free, then 0.6% fee on the balance.) Their recommendation is for slightly more aggressive investments, with quarterly readjustments. If I think beyond the fact that they're trying to get money out of me, I wonder if this is the next step up in the off-hands approach to investing...now, I just need the time to research this :-)

  6. MonkeyMama Says:

    I forgot to mention that the reason I picked a TDF was it was a cheap way to get a number of diversified managed funds, with only $50 to invest. I am invested in a T Rowe retirement fund. I think that one is a particularly good fund.

    Kind of the same line of thinking with the kids. Much more diversification for their $3k investment.

    My line of thinking may change as I have more assets to manage.

  7. Broken Arrow Says:

    LittleGopher, did they say precisely what that 0.6% is? Is that the entire expense ratio, or is that just a commission on top of the fund fees?

    If that's the entire expense ratio, and barring any other fees, it's not a bad deal. My current TDF ER is about that much. However, if it's a separate commission fee, then I say it's not worth it because you'll be making at least that amount in savings when you can just as easily do it on your own (as you are already doing).

  8. LittleGopher Says:

    After a little flipping through the papers, a little searching on the internet, a little calling (let's NOT make it easy)... This is a management fee of 0.6% annual (about .55% monthly, as this is how it's taken from the account)in addition to the expense ratio that's dependent on the funds (the proposed fund mix would be .26%, compared to the .2% on the current target fund we have now.)

    They've even given us the info on what they're recommending, so it's not like I couldn't do this myself...but I'd have to keep an eye on it and take the time to manage the account. I have less time (and bravery) now than ever! Of course, I could just leave it be....and that might not be so bad.

  9. Broken Arrow Says:

    Were it up to me, I would not take it. There's no telling whether they can out-perform an additional 0.6% each and every year to justify the cost. They may, or they may not, but no matter what happens, it's an extra layer of uncertainty for you.

    And if you're already with something like Vanguard's TDF, you're already enjoying a 0.2% total ER, possibly less. So... why would you want to add 0.6% to that?

    But anyway, that's my thinking. In the end, it's your money and your decision. I suppose it's always possible that they could out-perform the index. I don't know. Take a look at this previous entry as an example of how even smart managers and star funds can have a hard time beating the market in the long run....

  10. LittleGopher Says:

    Yeah, I too was thinking that any increased performance would probably be offset by the management fee. It was good to look into it a bit more (I was reminded by reading your entry and comments - so thank you!!)

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