During a guest appearance on “Live with Regis and Kelly,” pro skateboarder Shaun White attempted to jump (“ollie”) over Kelly Ripa using his board. Regis was quick to point out that White risked accidentally hitting and injuring his lovely co-host. White agreed. “That,” he explained, “is a risk I’m willing to take!”
Apparently, Invesco and Pacific Investment Management Company (PIMCO) are willing to take some risks with your retirement nest egg. Bloomberg reported these two funds are “adding riskier assets and complicated strategies in target-date funds as they seek to gain ground on Fidelity Investments and Vanguard Group in this fast-growing segment of the U.S. retirement market.”
Most investors would be surprised to find out that their target-date funds are getting riskier. Their stated purpose is to automatically adjust the investment allocation to reduce risk as the investor reaches a target date, typically retirement.
Risk reduction in a target-date fund is usually achieved by reducing the portion of allocation in stocks and increasing the allocation in fixed-income investments. So, should fund managers be increasing the risk in the fixed-income portion (in an effort to boost returns) through derivatives, credit default swaps, and other strategies?
Let’s look more closely at the pros and cons of target-date funds.
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We know that many of our clients do not feel qualified to select a fund allocation in their employer’s retirement plan. Target-date funds address that anxiety by leaving the decision in the hands of a fund manager. The investor picks a date when he or she plans to retire, and the fund manager makes the appropriate adjustments.
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As with most one-size-fits-all approaches, there are downsides to target-date funds. The first issue, as noted above, is that a mutual fund company might use alternate strategies that contain additional risk to obtain additional returns. Target-date fund fees tend to be high, and alternate strategies add further to fund expenses.
The second disadvantage is that there is no industry standard for the ratio of equity and fixed-income investments in target- date funds. In other words, the Fidelity Target-Date 2020 fund might be allocated very differently than Vanguard’s 2020 fund, even though both are marketed to people who plan to retire in 2020. A recent Securities and Exchange Commission survey found that few investors understand the differences in the design or risk profile among target-date series.
The third disadvantage is something called “glide paths.” This refers to how target-date funds change their allocations within a particular fund. In other words, a 25-year-old (like Shaun White) who invests in the fund today may not have the same allocation as a 25-year-old who invested in the same fund five years ago. Morningstar has found that some managers’ glide paths are much less stable than others. Funds with stable glide paths have lower fees.
Finally, disclosure about these differences in strategies, allocations, and glide paths is hard to understand.
Conclusion
To be fair, the allocation changes implemented by Invesco and PIMCO are not necessarily bad. However, to make an assessment, investors need more information than investment management firms usually provide. Has the allocation or glide path changed for a compelling, supportable, or rational reason? Do the changes benefit investors? Has the fee structure of the fund been affected?
Unfortunately, investors find that it’s difficult to get answers through their employer’s retirement plan. And they find it even harder to blend their target-date fund investment strategy with their other investments.
Working with BWFA, you know what you’re investing in, why, and how much it costs. We’ll also help you understand how your money in an employer-sponsored investment account is being handled and how that affects your overall portfolio. Contact us if you would like to review your investment allocation.