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This post is from GRS staff writer April Dykman.
During the 2008 financial crisis, target date, or life-cycle, funds were hit hard. People who were just a couple years away from retiring held 2010 target date funds that lost 24% of their fund’s assets on average, with a range of 9% loss to a staggering 41%.
Same date, different allocation
According to the Securities and Exchange Commission (SEC), many investors believed that their asset mix would become more conservative as they neared the target date. But what many didn’t know was that the amount of risk could vary widely, even among funds with the same target date. From the Washington Post:
The SEC said that life-cycle funds with the same target date had equity exposures that ranged from 25 percent in stocks to 65 percent. It could be years after the target date is reached before a particular fund’s asset mix switched to a more conservative approach.
Proposed rules to educate investors
To increase investor understanding of how these funds work, last month the SEC proposed new rules for target date funds in a 100-page report and is seeking comments from the public about the proposal. The highlights include the following:
- Marketing materials would have to disclose the asset allocation as a tag line with the fund’s name the first time that name is used. The proposed rule would allow an investment company to list a range of allocation for an asset class, such as “30-35%”.
- Target date firms will have to provide investors with a graphic depiction of asset allocation for the life of the fund (from start date to target date).
- Firms will have to provide investors with a statement explaining that the asset allocation changes over time, stating the year the asset allocation becomes final, and providing the final asset mix.
- Marketing materials will have to advise the investor to consider his or her risk tolerance and financial situation; that it’s possible to lose money; and whether the planned percentage allocations can be changed without a shareholder vote.
Finally, target date funds have been touted as a “set it and forget it” solution to retirement, but being too hands-off with your money has consequences. To address this, the SEC proposed changes to its antifraud guidance to address the age emphasis and “set it and forget it” representations of target date funds. The SEC noted that marketing materials that lead investors to believe an investment is appropriate for them based solely on age (or target age of retirement) or that the plan is easy and doesn’t require monitoring, are misleading.
Are rules tough enough?
While most experts agree that more disclosure is good news for investors, others don’t believe the SEC rules are tough enough. Criticisms include the following:
- The phrase “target date” is misleading and should not be allowed to be used in a fund’s name. The perception is that a 2030 target date fund will provide retirement income for an investor in 2030, and disclaimers are unlikely to change that perception.
- Some experts don’t mind the name, but feel like complicated graphs and confusing fact sheets won’t be easily understood by the average investor. Instead the investor should be told what sort of income is probable given their investments, rate of savings, asset mix, and years until retirement.
- The SEC should do more to explain that target date funds are not guaranteed. Critics point to the fact that the Employee Benefits Security Administration has deemed target date funds as a Qualified Default Investment Alternative (QDIA). In plain English, this means that if an employee neglects to direct their 401K investments, the employer can select a target date fund for them without being held liable. So while the SEC can say the funds aren’t guaranteed, the fact that they are a QDIA will continue to send the wrong signal to many investors.
Target date funds are still a good option for many people, but it’s wise to invest with your eyes open. To help investors better understand target date funds and what to know before investing, the SEC and the Department of Labor issued an Investor Bulletin that explains how the funds work, how to evaluate them, and what to know before investing.
Personally, I’m a fan of target date funds because despite writing about personal finance almost daily, retirement talk makes my eyes glaze over. Nevertheless, I am one of those investors who picked a target date fund without fully understanding much of what the SEC wants to clarify, and now I appreciate how important it is to do some homework when choosing a target date fund.
This article is about Investing, News, Retirement Tuesday, 20th July 2010 (by April Dykman)
Seems to me like the disclosures are a good idea. It’s important for investors to know the actual asset allocation of what they’re investing in.
Most of these disclosures appear to be from suggestions made in John Rekenthaler’s testimony to the Senate Committee on Aging. (Rekenthaler is the VP of research for Morningstar.)
Unfortunately, they don’t appear to have picked up his suggestion about more prominent disclosures for fees. Vanguard’s target date funds charge 0.19% per year. The next cheapest target date funds carry an expense ratio of 0.64% — more than 3 times as high!
I understand the need for disclosure and making things clear to investors. But at the same time, no matter how much disclosure there is, there are always going to be people that ignore the details (myself included).
More disclosure is almost always better.
I like the idea of target date funds; I believe we’re using them with the kids’ 529 accounts.
I’m not big on the retirement investments either, April — my husband had a job in finance for a while, and liked it, so I let him make most of those picks.
I’m sure most of these investors have heard of the Great Depression, so they should be vaguely aware that equities can lose value. Equities are not a smooth ride to 10% returns, and by no means a guarantee. Unfortunately we tend to forget the past and are doomed to repeat it in the future.
Most of the SEC education requirements are already included in each fund’s prospectus. If investors read and understood the fund’s prospectus, they would have been aware of how the fund operates. This is additional legislation to provide information that will yet again be ignored or misunderstood by the majority of investors.
I strongly support life-cycle or target date funds because they provide a low cost, automated shift to asset allocations as people approach retirement. Particularly the low cost Vanguard fund (.20% expense ratio, the lowest of such funds).
Interestingly, the criticism of Target Date funds in a recent GRS post and, more so, in the comments, was that they are TOO SIMPLE. That people should look into more complex investments because then they might make better investment decisions. Here, the funds are too hard to understand how they change over time “according to some” … there they were too simple a tool for necessarily complex optimal retirement planning.
In fact, as JD mentioned in “Your Money: The Missing Manual”, Target Funds generally balance:
(1) complexity (diversified, shifting allocations over time) and
(2) “invest and forget” simplicity.
It is a BRILLIANT idea to allow these funds as “Qualified Default Investment Alternative”! This is exactly the type of policy that is suggested by behavioral research as outlined in “Nudge: Improving Decisions About Health, Wealth, and Happiness by Richard H. Thaler (Business) and Prof. Cass R. Sunstein (Law). Personally, I’m working to make these (Vanguard) funds available and recommended as defaults for employees at my office for the low fee and “invest and forget” simplicity … as opposed to the high fee funds currently recommended which never shift their allocations unless people decide to drag themselves to HR to make the change.
The performance of end-of-term target funds in 2008 is a perfect example of why “simplifying your finances” (too much) can hurt you.
If nothing else, investors should have a clear idea of what their asset allocation and risk level is. This isn’t obvious with target funds and when fund companies make mistakes, then the investors lose out.
For most people, target funds are ok, even if you don’t know what is inside them. If you are approaching retirement however, you better make sure you know what your funds are investing in.
I am more interested in the fees actual $ amounts being disclosed. Most of these changes already are in the investment’s prospectus, if investors are ignoring that, they are likely to also ignore any of the new information this new regulation would provide. This may simplify things, but I can see right now the mix of stocks vs bonds, and the top stocks and funds being held.
However, I am still confused by the fees. When are they taken out, how much exactly, etc. Yes, you can dig around and find that %, but you still don’t know the actual amount you paid.
Val: The fees for a mutual fund are deducted every day. The amount charged each day should be equal to roughly the annual expense ratio, divided by the number of business days in a year, times the size of your holdings in that fund.
I absolutely agree with the second point in the section “Are rules tough enough”. There are not a lot of citizens out there who understand the financial terminology. So at the end of the day all this would still be confusing to them.
Once again, big brother feels the need to protect the fools from themselves.
If someone doesn’t understand a target date fund now, more disclosure isn’t going to make it any clearer.
All these new rules will accomplish is a rise in fees by the fund companies to cover the extra paperwork. And, of course, the justification of needing more government employees to oversee and protect us meek and needy individuals from the big and bad finance industry.
I always wish the pictures in April’s posts had a title or a saying when your roll over them.
Mike:
“The amount charged each day should be equal to roughly the annual expense ratio, divided by the number of business days in a year, times the size of your holdings in that fund.”
Thanks! But, there is no way I will ever figure out the exact amount, and I consider myself fairly math-saavy.
If my “holdings” change, the amount charged changes. I would have to do this calculation every time I add money to the funds, which is automated, and probably have to do it every time the market value changed? It is very difficult for the average invester to get this amount, but the fund’s company HAS this information already, but isn’t showing it.
Val: You’re right, it would be a pain to calculate the dollar amount that you’re paying each day.
Why not just look for funds that have low expense ratios?
Val - I agree with Mike. Why do you want to calculate the $ amount of fees charged?
I do look at the lowest expense ratios, but my 401k has limited options, and I am sure that whatever the fees are, my employer match makes up for it. I use Vanguard for anything else, they tend to have the lowest fees.
And just because it is a low expense ratio doesn’t make it alright that consumers have no idea what the actual amount ended up being.
401(k)s are worse, because there are fees other than the expense ratio for each fund that I also cannot see! It makes me wonder when I put anything into a “safe” fund like the money market one with a tiny return, if with all the fees I am losing money (I have since taken all money out of the money market one, for supposedly risk free investments, I don’t use my 401(k)!).
And why WOULDN’T I want to know how much in fees I pay?
The point of a target-date fund is for people who don’t want to think about it to be able to get a larger return than what a money market fund provides. (In fact, most plan defaults put money in money market funds, according to a talk I went to last week.) Remember: default funds are for people who are satisficing, not optimizing. They’re to nudge people into putting *something* away for retirement and reasonably good defaults are very sticky (people stay in them). It is in people’s best interests to at least have some of their default in the stock market rather than in a bank.
I think regulation should focus on target-date funds that are allowed in default plans. I think those target-date funds should have a specific name that is different than all other target-date funds. Maybe call them “default-target-date funds.” The regulation needs to focus on allocation and fees. They should only allow low-fee index funds in the target and they should cap fees at whatever Fidelity (or some other non-Vanguard fund) is currently providing.
(Capping at what Vanguard provides is unreasonable for profit-seeking funds– hopefully competition will drive those fees down on average as these grow more popular. But, if fees aren’t capped, those numbers are going to go way out of kilter in some plans with limited options– it’s a possibility for fraud. Using current limits for a respected company proves the number can be done while limiting opportunities for preying on ignorance.)
Non-default target-date plans can be kept unregulated. Except– I really really want fees on all of these darned retirement plans to have to be shown and have to be in the same format so they can be easily compared. That drove me crazy recently when trying to figure out which plan to switch to. Some example with money amounts of fees for different savings amounts would really drive down the fees that say, Ing, charges. And the fact that Ing charges an additional 0.7% extra on top of whatever you pick needs to be prominently displayed on something that is signed. (Yes, I’m bitter. But I’m about to move my retirement funds. )
And it is important to explain that stocks can lose value and neither returns nor principal are guaranteed by the government. But that shouldn’t apply solely to default plans.
Val: You’re right about 401k plans often charging fees on top of the fund fees. It should be disclosed in the plan documents though.
And just to be clear, I’m not arguing against knowing how much you’re paying. (I’m downright miserly when it comes to investment costs!) I’m just making the case that it’s (usually) more useful as a percentage than as a dollar amount.
For instance, to answer your question of whether a money market in a 401k would lose money, you’d need to see how the expenses — expressed as a percentage — compare to the yield on the fund.
My employer’s 401K plan includes T. Rowe Price target date funds. They are touted as being different from other company’s target funds with the same date, because they take into consideration a 25-30 year lifespan after retirement. This means they are going to be more aggressive for a longer period of time than one might expect based on target date alone. If all 2025 funds are not alike, maybe they shouldn’t put the date in the fund title.
Perhaps, funds like the Vanguard LifeStrategy funds would make it more clear how much risk a fund is taking. For investors who pay attention and would want to decide when to switch to a less risky mix, these would be easier.
Target date funds not necessarily meaning what you think they mean…another example of how interests of Wall St and of individual investors diverge.
At least target date funds are trying to be longer-range oriented. They seem like a better choice than many other options at the moment, but it’s hard for one fund to fit every investor! I spent almost 20 yrs on Wall St; imho most funds are focused on 3 mo or less time horizons (nothing evil - just that’s how often their performance is widely reviewed); most investors have horizons of 10-40yrs or more (if you’re 30, want to retire at 50, expect to live until 80, that’s one 20yr goal and one 50 yr goal). That is some mis-match!
Imho, the best way in the current market regulatory structure for individuals to make wise decisions is
#1, know your goals (2 people with identical $ may have very different risk tolerance) - many advisors gloss over this, and start with $ amounts not hopes/dreams/comfort levels;
#2 follow the money- - pay for wisdom, not transactional churning (that is, either use a fee-based non-trading-compensated investment advisor combined with a low-cost diy investment account, or do your own research if you have the confidence);
#3 check back once or twice a year to see if you need to make adjustments in either goals or holdings (I advocate adjustment through allocation of new$, rather than spending time & fees moving $ from one class/investment to another). Big market swings can often have fixed income & equities acting differently and can really shift your allocation, even if you did nothing…
These aren’t written in stone - I would be interested to hear what other folks’ best practices are. Full disclosure, I am currently working as an in-house analyst for a family business, that is I am not charging anyone for investment advice.
Val, do you break your cable bill down to a daily charge?
I hear what you are saying, but in some cases, a good estimate is just as useful as the exact figure.
“Personally, I’m a fan of target date funds because despite writing about personal finance almost daily, retirement talk makes my eyes glaze over.”
That describes me 100%. My 401(k) is in the Vanguard 2035 target date fund and our current Roth IRA is in the Fidelity 2040 target date fund. They will stay there for another 15 years at least before I start researching the best options for us 10 years before we retire.
Our next Roth IRA will be invested in individual high dividend, long-term growth stocks like our Scottrade account…that’s done by Mr. BFS since all of that is just too much/boring for me.
Money Smarts – no, I am not trying to calculate the fees on my funds – I am saying that the fund’s company HAS this number, and hides it from the investor, and I think that they should be required to show it. The only way to know what you paid annually is to figure out that daily charge, as it varies each day, and I doubt anyone really does that. I already get a monthly bill of my cable fees, including itemization that shows the dollar amounts of any taxes that were calculated from a %. I don’t get ANY bill AT ALL of my fund fees. I don’t see why if the companies already have this information, they aren’t required to post it, and instead hide it completely. In addition, they make it difficult to find that fee info anyway, buried in the same mess of paperwork that the info on target date allocations is in. I would say the majority of the people who complained that they didn’t know what % stocks their target date funds are also don’t know what fees they pay.
Why should investors have to calculate their own a “good estimate” of what they already paid when the real number is available, and why do the companies need to be required to make the allocations super obvious, and still are allowed to bury the fees?
I will stick with good S&P-tracking ETFs and bond funds. I rebalance every quarter - that’s how I get my own target date.
There are two reasons I have no plans to switch to target-date funds:
1) the fees are higher, which drags down overall performance a lot
2) I don’t trust them! Look what happened two years ago - like April says in the article, lots of people who relied on target-date funds got screwed. They thought that the funds were getting more conservative as they got closer to that target date, when in fact that was not always true. At least when I choose my own allocations through ETFs and bond funds, I am getting what I pay for.
The comments here are precisely why I read this site!
I’m a set-it-and-forget-it type. We all have blind spots. I think the aim here is/should be to help people make an OK decision, if not the best decision they could make with a lot of research. Many of us just won’t spend the time to do the work. I was going to mention the book ‘Nudge’ but someone beat me to it already!
I also agree with Val - your quarterly statement SHOULD show just exactly how many dollars and cents the fund took from your account! But imagine if Congress passed that requirement! There would be a scramble to the bottom. It would be too easy to shop around for a better price. It would be the end of easy fees for Wall Street. There’s no way the lobbyists and financial firms will let it happen.
Personally, the fact that I know the percentage of the fees charged on my 401k but I never actually see the money removed or the fees written on my statement drives me a bit batty. I’m fairly good at math, but it seems like an unreasonable amount of subterfuge.
@25 Ash (and Val and Kristen and earlier posters) That drives me nuts too.
Of course, the 457 plan at our place gives dollar amounts instead of percents and that was a bit annoying too since I had to convert to make a comparison. (And when I tried to do it in my head I got it off by a factor of 100 the first time…) They ALL need to put in the dollar amounts with examples so they can be easily compared in a way that is real and makes sense. (If you had 10K saved, then your fees would be X…)
#10 Brian–EXACTLY.
I have to say that all of this having to protect people because they don’t take the time to read up on things is really getting old. There was an article recently (yesterday or day before) about title loans and how people didn’t realize the percentages, etc. The quote from one guy was how he rushed through it and didn’t read it carefully. Can’t save someone like that from themselves.
Personally, I love the target funds. I know any investing is risky–you want to make sure you will still have your $100 in 40 years, then put it in the bank making .3% or in a coffee can in your closet. People look at the past returns and think that is going to be a given in the future. That is just dumb.
Not taking the time to understand your asset allocation in what should be one of the largest pieces of your net worth is just flat out irresponsible. Your 401k is your money, it’s not the goverment’s or anyone else’s responsibility.
Disclosure is good for the retail investor, but if people actually cared to know what these funds are doing they would be forced to disclose the relevant information to win over investors. I find it hard to believe that this information isn’t already available in most prospectus documents anyway.
Hah, somehow I missed this article (USA Today):
Disclosure rules for 401(k) fees are on the way (slowly)
The Department of Labor wants 401k plan providers to disclose all the fees and how they collect them in writing. The fees would be disclosed as a percentage of plan assets or a per-person charge. Here’s hoping the rules go through!