Pitfalls of Target Date Funds… and some proposed replacements

The LinkedIn Group Communities are abuzz with the idea that, even as popular as they have become, Target Date Funds (TDFs) are just not wonderful after all…

Several fixes have been proposed. I’ve done so myself. as you know. This one is from plansponsor.com “A Better Option than Target Date Funds” and needs some cautionary commentary.
What to say when you agree that Target Date Funds are a sham, and do little to prepare 401k plan participants for retirement?

But what to shout out loud, when the fix for a low income, inappropriate asset allocation, is a “half-gainer” into a river of high risk speculations being promoted as “alternative investment” asset classes!

Note that “alternative investment” is a euphemism for those high risk mechanisms described in Investments 101 textbooks as “speculations”.

No matter how they are sliced, diced, sauteed, or seasoned, no recipe for speculations will ever produce the taste of a fundamentally sound investment.

Similarly, when considering ETF derivatives, the risk increases exponentially with each level, so a fund of funds is likely to be riskier than the funds it contains.

The article mistakenly merges all “Life Cycle” programs and products into the TDF category. There are at least three that are retirement income focused, and asset allocated to accommodate several different risk tolerances at retirement.

They are constructed with Investment Grade Value Stocks and Income ETFs. Not sexy at all, but they should provide lower drawdowns and higher income… and they can be converted security-for-security into a rollover retirement portfolio at any time.

Target date funds do not prepare us for retirement, though they may shield us a bit from maximum correction drawdowns.

My concern with them is that the inappropriate DOL/SEC focus on fund expenses and market value is (all good intentions aside) producing a low income retirement scenario that will only generate enough income if the market never, ever, goes down.

The popular Vanguard Target 2015, for example, is more than 50% in the stock market (with no signs of reducing exposure) and generating much less than 2% in spending money.

The fund holds positions in more than 5,000 different stocks (there are less than 500 Investment Grade Value Stocks)… clearly not a retirement fund in any sense of the word. The ideal “retirement fund” never invades principal, thus allowing for growth in the annual income provided.

But the portfolio alternative being proposed in the PlanSponsor.com article is absurd, or should be to any plan sponsor or fiduciary.

Commodities, private real estate, private equity speculations, and hedge funds may well be alternative asset classes BUT they are absolutely not investments. These are textbook speculations, nothing more, and certainly nothing that should ever be considered  suitable for a retirement program.