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Target date funds are not right for you!

Tuesday, July 12th, 2016

I know that the title of this newsletter is a bit strange because you must be thinking, “They must be right for someone?” The answer is they are not right for anyone, because they try to fit everyone during many years, some as many as 40 years.

There is currently over $24 trillion in retirement funds in the U.S., and while I couldn’t find a good number of how much is in target date funds, the numbers I saw were high enough to scare me.

Why am I so against target date funds? There are any reasons; let me share a few.

First off, they are trying to predict the future by saying when you retire it is a good idea to have most of your assets in bonds versus stocks.

We are currently at the end of a long bull market in bonds. If your target date is close, your performance will suffer as bonds decline and interest rates rise; just when retirement is around the corner your account will take a big hit.

Target date funds are meant to become more conservative as you get closer to retirement, because bonds are supposed to be less risky than stocks (which they are, however that is not always the case.)

Any advisor with 30 years of experience would know this is not always the case based on history. Interest rates go up and down and the cycle may be long sometimes, but nothing stays the same forever.

I will call it humorous, to be nice, regarding how these funds are managed. Take a look at what your money is invested in, and you will be surprised you actually own more mutual funds within the same fund company; sometimes 20-25 of their own funds.

Wow, what a great way for the mutual fund company to make more fees, charge 1/2- to 1% for the target fund management fee, and then invest the clients’ money in your own mutual funds that charge another ½ to 1% for those funds.

I hope you are not paying a broker management fees or commissions on top of the internal fees. You must also be careful of the fund company your money is with, because in some occurrences the mutual fund company will charge a sales charge to invest in their funds within the target date fund. I wonder how many investors have no idea this is happening.

It is also important for investors to understand risk capacity versus risk tolerance.

The term risk tolerance is tossed around a lot, and is when a broker may ask you what your tolerance for risk is. If you don’t understand how stocks work and have fear of the unknown, you tell the broker you have a low tolerance despite being only 45 years old. Your capacity for risk is more important and can come through good investment education.

A 70 year-old man should not have the same amount of his investments in stocks as the 45 year-old man.

The 70 year-old should have more money in short-term investments, like CD’s and money markets, which are available on short notice for medical emergencies and other short-term needs.

This doesn’t mean they should have nothing in stocks, or a very small amount. A seventy year-old today has a good chance of living well into their eighties or nineties. In the U.S., there are currently around 72,000 centenarians and people over the age 100 and it is expected to more than double in the next four years. So even at 70, one could easily have another 15 to 30 years to live.

Since my firm invests in value companies that are less risky than many stocks, I feel comfortable with a higher portion of my clients’ assets in stocks (especially including some dividend-paying stocks) in their portfolio.

I always talk about how great Wall Street is in designing products to make you feel comfortable and make them a lot of money. Target date funds were a big winner for Wall Street and feeds off the needs of people who want to do and know nothing and hope everything turns out okay.

Can you imagine planning your vacation once and never having to change it? That would not work out too well because life changes as time goes on and, sorry to say, if you want to have a good retirement you need to spend some time understanding your portfolio with a qualified investment advisor. 

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