In April, 2022 a fraternity brother of mine who's just about exactly my age wanted my two cents about about his 401k which he had entirely invested in Vanguard 2030 Target Date Fund (VTHRX). He has since retired but is not yet accessing this piece of money. Three and half years ago, the 401k balance was a little over $400,000 which testfol.io says is now $553,000. That's a useful piece of money but I do not know if it is sufficient for his needs or if there are other accounts. I do know his house is long since paid for.
My comments to him about VTHRX were pretty much exactly what I say now about target date funds. They can get the job done but they are not optimal. They torched people in the Financial Crisis when they were a pretty new product and they torched people in 2022. VTHRX had a 50% decline at it's Financial Crisis low when it presumably had more in equities. The 2020 Pandemic Crash decline was 24% and in 2022 it was down 21%.
Actually, holders were only truly torched if they panicked out because the fund of course went on to move higher. It has taken a suboptimal path to higher levels so it's valid but it has been a tough hold. This is good framing for all target date funds. An adequate savings rate with no bad decisions (panic selling) should get the job with a suboptimal but valid investment choice.
Since its inception, VTHRX has compounded at 7.09% per testfol.io versus 8.22% for VBIAX. VTHRX has gotten that result with more volatility than VBIAX so again, not optimal but compounding at seven something percent can get it done. Putting it all into something that compounds at 4% will have a tough time getting it done unless the account in question won't play a primary role in a retirement plan. I'm not sure where the dividing line is but I do think 7% can be adequate.
Like many people, my college buddy doesn't have a whole lot of interest in making a full time job out of his 401k and so some adequate choice has resulted in a decent sized account. Whether it is enough or not for him boils down to whether he saved enough (I don't know) but assuming 4%, $553,000 would pay $22,000/yr.
Now this from the WSJ that Vanguard is going to roll out a suite of target date funds that will embed an annuity into the package. Annuities are very complex and the article did not really dig in to the complexity of this new product but anyone signs up for this will, from age 55, start to have money segregated as part of the fixed income sleeve to be later moved into the annuity portion. The article said that 25% of the account will ultimately go to the annuity and based on today's numbers for a $1 million 401k, $250,000 would go into the annuity and pay $1670/mo which is about 8% annually. There will be a way to have a survivor benefit and a benefit for heirs but of course both will cost more money either with a higher fee or more likely a smaller payout.
Remember, we're dealing in the realm of suboptimal but adequate.
To my buddy and his $553,000 401k, a quarter of that annuitized with the details that the WSJ gave means $138,000 paying 8%/yr or $11,000 plus $16,000 (4% of the remaining $415,000). This works out to $27,000/yr versus $22,000. That's not a life changing difference but it's not nothing either.
All the drawbacks about annuities, I agree. I'm not an annuity salesman, I've never sold one and it's not going to happen in the future but all the drawbacks and fees notwithstanding, this would be the right answer for some people. You have no real interest in actively engaging or hiring someone to do that for you. It's your money you are entitled to do what ever you want. Buffer funds are suboptimal but people love them. If at some point, the CAGR is too low, that's going to be a problem for anyone going all in on a buffer fund.
For what it's worth, Copilot says the oldest buffer fund is the Innovator S&P 500 Buffer ETF (BJUL) although it isn't that big with just under $300 million in assets. Per testfol.io, since inception, BJUL has compounded at 9.77% which is a little better than VBIAX and lags far behind the S&P 500 at 14.25%. I don't know the details of BJUL but for someone with no real interest in actively engaging or hiring someone to do it for them, it seems adequate.
I don't think anyone reading this blog is going to want to use a target date fund, a target date fund with an annuity embedded or a buffer fund but if you are reading this blog, then there is a decent chance you are the one that family and friends go to for investing input. Someone not interested in really engaging but realizing they need to do something is looking for an easy path even if that is not the optimal path. If you're the go to, I would encourage educating on the drawbacks but realize they probably want target date funds and buffer funds all the same.
I'll close out saying that calling buffer funds suboptimal might be overly charitable. Yes, they can compound positively, no question but the simple big drawback is there is more risk than potential reward with the "plain vanilla" fund in this niche. The upside is capped. On the way down, holders are spared the first x% like maybe 9% or 15% and then exposed to the remainder of the decline. If the S&P 500 ever cuts in half again, holders might end up down 41% in a down 50% world. There might be newer funds that address this issue which speaks to another point which is they are more complex than they first appear.
The thing with risk management is you don't need it until you need it.
The information, analysis and opinions expressed herein reflect our judgment and opinions as of the date of writing and are subject to change at any time without notice. They are not intended to constitute legal, tax, securities or investment advice or a recommended course of action in any given situation.
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