Target date funds began in the early 1990’s. I always disagreed with the concept.
I will agree that they are a low-cost passive way to invest. I agree most employee participants do not want to make investment decisions. Meaning they do not want to pick the funds their salary deferrals invested in. When I enroll employees into a 401k plan or SIMPLE IRA plan it took the most effort to get the employee to agree to defer money into the plan. Then when I asked the employee where they wanted their money to be invested in, I would receive a blank stare 85% of the time.
Taking a step back the root cause of having the employees pick their funds was started with the 401k plan. I was always against allowing the employees to pick their own funds. First of all, back then and even still now the cost was excessive. The costs have dramatically reduced over the decades, but there has always been a better way.
Originally the Trustees of the plan hired a securities broker, money manager, insurance company or agent, or a trust department of a bank to manage the money. That would leave one account to manage, one set of books to account for, and no multiple small accounts nor individual trading to account for and increase the costs of the plan. Prior to 401ks we would conduct one annual accounting of the plan assets on one account. The valuation was at the end of the calendar or fiscal year. The employees received one statement per year as to what they accumulated. A very simple and inexpensive plan model.
But 401ks changed that. And from them began self-management of the accounts. In the beginning there was no software to divvy up the accounts. I watched the birth and changes of the software and the expense it created. I watched what we did on green account ledger paper evolve to looking up your 401k account on your phone.
But with all of that technology we as advisors, securities brokers, insurance agents and consultants suddenly were not allowed to help the employees pick their sub-accounts (mutual funds) because some regulators decided we should not do so. All we were allowed to do is provide information and the list of sub accounts to select from.
Then the Target Date Funds were created while this evolution occurred. My consternation with these funds is you were stuck in a S & P 500 index and a bond index. Based on your age you would have a higher percentage invested in stocks and a lower percentage invested in bonds if you were younger. And this would reverse as you aged until you had more invested in bonds than stocks. The theory being that you need to take less risk when you are older.
I disagreed with this premise. There are so many great investment managers that you missed out on using. I also believe you do not up and quit investing once you retire. You will still need growth for another 30 to 40 years during retirement. And most importantly the freight train is coming up ahead. The potential rise in interest rates.
In the late 1970’s and early 1980’s interest rates were extremely high. As high as 18 to 20%. And since then, which spans my career, rates have steadily dropped. Now the pendulum is beginning to swing the other way. Higher interest rates are here. In 2022 the Fed increased interest rates and caused the bond prices to drop precipitously. It also caused the stock market to have four corrections in that year. So, guess what, both stocks and bonds had huge losses. Target date funds also had huge losses.
I actually for many years, actually decades, before this told employees to stay out of Target Date Funds and Bond Funds for this very reason. I told them to put the safe money that normally was invested in bonds into the money market or guaranteed fixed account. These accounts paid low interest, but they did not lose money.
Which brings me to why I am writing about this. I recently conducted a comparison of the performances of a Lifestyle Growth fund (Target Date fund) to a managed account. The period covered January 2017 to June 2024. I was surprised as to how right I was!
The Lifestyle fund earned 52.96% or 5.83 % average vs. the managed account which earned 240.46 % or 17.76% average rate of return. Of course, this is back tested cherry picking looking back in the rearview mirror. But that is a huge difference.