By David M. Haviland, Beaumont Capital Management
Few investment products currently garner more attention than target date funds. Launched 30 years ago, TDFs are the most common qualified default investment alternative used in 401(k)s today, and they claim a sizable portion of the average investor’s retirement portfolio.
It’s surprising then that as advisors, we are so bad at selecting TDFs that actually work as our clients believe they will.
By recommending products based on outdated models and assumptions, advisors often lead clients into risks they don’t need and traps they don’t want. It’s time to leave old habits behind and ensure clients avoid typical TDF mistakes: unhelpful diversification, flawed glidepath strategies and unwanted risk.
Diversifying or ‘De-worsifying?’
We’ve all prayed at the altar of asset diversification. It’s the most basic portfolio protection strategy. And in “normal” market conditions, asset allocation and diversity can help. However, markets are not always normal.
During bear markets, asset-class risk often correlates towards one and diversity offers little defensive benefit. In 2008, world equity markets failed as did the diversifiers, such as gold. Today’s TDF fund managers are still relying on this “de-worsifying” approach by adding riskier master limited partnerships, real estate investment trusts and other sub-equity classes to funds.
Many are also adding large amounts of junk and emerging-market bonds to compete on performance. But these are not “safe” and they too tend to correlate with equities in tough economic times. All asset classes suffer from bear markets, and many of these so-called diversifiers have performed even worse than the S&P 500.
Dangerous Gliding
Each TDF employs a glidepath — a formula to rebalance assets annually to reduce risk as the targeted date approaches. Most glidepaths are set on a predetermined asset allocation trajectory that slowly reduces equity exposure over time. But they are nothing more than a series of diversified asset allocations.
Worse yet, when glidepaths were last tested in 2008, many crashed. The 2010 TDFs of the largest providers lost between 21% and 31% in 2008. If your clients lost almost a third of their savings within two years of retirement, could they still afford to retire? Not most people.
If you haven’t reviewed your recommended TDFs’ glidepath strategies, do so immediately. You may be saving your clients from a very hard landing.
Listen Up
Possibly the biggest mistake TDF managers make is not listening to what clients want. Thus, we just repeatedly follow our own outdated misconceptions.