Should Clients be Using Target Date Funds?
To use the OnPointe Quick Score App that I used to generate the risk score, CAGR, and maximum drawdown numbers used for this newsletter, click on the following link:
Target date retirement funds seem to be getting a lot of press these days and as such, clients are pouring billions of dollars into them.
The question is, should they?
What are target date funds? It’s a mutual fund seeking to grow assets for a future target date. For example, someone who wants to retire in 12 years might use a 2030 target date fund.
Assets are “supposed to” be managed in the fund to maximize growth and minimize loss in a manner that is prudent given the years left until the target is reached. A target date fund’s risk tolerance is “supposed to” become more conservative as it approaches its target date.
Target date funds are essentially asset allocated funds. Depending on the age of the client and the target date, the mix might be 60/40, 70/30, 50/50, etc. stocks to bonds.
Target date funds are the epitome of K-I-S-S (keep it simple stupid)
Target date funds are pure genius from a marketing perspective. The sales pitch is…client, if you give us your money and keep it with us for 15, 20, 35+ years, we will:
1) Help you achieve your retirement goal.
2) Generate good returns in up years and provide some protection in down years.
3) Reallocate to lessen your risk of loss as you age.
And if the client uses Vanguard’s target date funds, the cost per year will be very small.
But will target date funds fulfill as promised? I don’t think so.
Using examples is usually the best way to get my point across in newsletters. I’m going to look at Vanguard’s target date funds ending in 2030, 2025, and 2020. That means the current age of each investor would retire in 12, 7, and 2 years respectively. I chose these examples to show how risky each fund is and why I do NOT find them suitable investments.
I used our OnPointe Investment Risk program to run the numbers to score each mutual fund and calculate the maximum drawdown risk going back to the last crash as well as the compound annual growth rate (CAGR) going back 10 years.
|2030 Fund||2025 Fund||2020 Fund||S&P 500||60/40 Balanced|
What is wrong with these numbers?
Keep in mind that the three examples I’m using are clients that are 53-, 58-, and 63-years old if their target retirement age is 65. To me, that means these clients should NOT be in an investment mix that will risk a big drawdown.
1) All three have a risk score on the OnPointe 1-100 scale of more than 50.
2) The maximum drawdown is huge for all three (-38%, -42%, -46%).
3) The CAGR over time is not good for the risk taken.
4) A classic 60/40 mix of stock/bond yielded a higher CAGR and had lower drawdown risk.
5) While the S&P 500 had slightly more risk than two of the target date funds, at least it generates a much higher CAGR.
If you just looked at the numbers above would you recommend target date funds?
I wouldn’t, but there are billions of dollars in these funds because consumers don’t know any better.
Most financial planners do not use target date funds. In fact, most don’t like them because the goal with these funds is to replace a financial planner. If a client can put money in a target date fund and generate similar returns to what they would have received by working with a financial planner at significantly less cost, that’s a problem.
However as the numbers above indicate, target date funds have not performed well historically and, in my opinion, have far too much risk for the returns generated.
Roccy DeFrancesco, JD