I Hate Target Date Funds

Alternative titles for this post could be I Still Hate Target Date Funds or Target Date Funds Suck.

When target date funds first hit the market, my reaction was negative because there will be times during the stock market cycle where you will want to adjust your mix of stocks, bonds and cash but not necessarily do so as prescribed based just on the academic process to create fund in the first place. 

Then came the financial crisis and another issue that popped up is that they all have different glide paths reducing stock exposure to favor more fixed income. One fund with a target date of 2032 might today have 70% in stocks while another might have 55%. 

Our firm got a good sized 401k plan as an account before the financial crisis was over due to how poorly their target date funds did as the stock market imploded. Target funds now are not looking so hot and discussed in this article at Marketwatch. Very coincidentally, a college buddy asked for my two cents on his 2030 target date fund. It was a little over 60% in stocks so just kind of a coincidence that it's close to 60/40. I would note that a small portion was allocated to a TIPS fund. The YTD performance when I looked a couple of weeks ago was that the 60/40 mix was down about as much as the S&P 500 because most of the bond exposure was longer dated so the fund was (still is, I imagine) taking a lot of interest rate risk.

The chart compares the S&P 500 VBAIX which is a fund proxy for a 60/40 portfolio, an aggregate bond index fund (AGG) and the iShares 10-20 Year Treasury ETF (TLT).

 

Taking interest rate risk has looked a whole lot like taking equity market risk. A thing I like to say is if everything you own goes up together, then they are likely to go down together too and that appears to be happening in the chart and by extension a lot of target date funds. 

I've been writing for many years about not wanting meaningful exposure interest rate risk. In the last couple of weeks, I've done a little buying of shorter duration fixed income getting close to 2.5% for less than two years compared to less than 2% for ten years not that long ago. Target date funds don't really allow for that sort of engagement and based on their long term track record, that only seems to matter when things go bad in the market like the financial crisis or now. Put differently, they don't offer protection when you need protection. 

If your 401k only has target date funds, I guess I'd ask for a more robust offering but I would forget about matching up when you think you're going to retire with the fund you choose. Decide how much you want in equities and then use the furthest out target date fund for your equity exposure. A 2060 fund is going to have a lot in equities. If there's no fund offered that avoids interest rate risk then I'd just have a money market. You'll have to decide the allocation between stocks and money market of course but I would continue to avoid meaningful exposure to interest rate risk for a while still.