Target Date Funds, Buyer Beware

I recently came across an article in an industry publication that really, quite frankly, irritated me.  The authors of the article seemed to be lauding the recent performance of target date funds, and how wonderfully they were doing for retirement plan participants.

If you are not aware of what a target date fund is, it is typically a “fund of funds”, or a single fund comprised of many underlying funds.  The ideas is, that as a person nears retirement, the composition of the fund automatically slides from being more aggressive, to being more conservative.  It is supposed to be a simple, one stop shop solution; addressing risk as you age, and also providing “diversification” in one fund, due to its structure.  They often have a year in their name.

The most troubling part of the article for me was how it was showcasing the great “3 year returns” of selected target date funds.  These funds were all fairly equity based, as the ones I will reference were all “2045” funds, in other words designed for folks retiring in 2045.  Sure, the three funds I will reference did return 15-16% annualized over the three years, but no one bothered to look inside and ask “why?”.

I am going to tell you what each of these funds owns, and you can tell me why perhaps this performance, although pleasing, may not be high for the right reasons.  Just because you get good results, the ends do not justify the means.

First we will look at T. Rowe Price Retirement 2045.  According to my analysis, this fund contains 52.49% Large US Company Stocks, 31.49% Large Int’l Stocks, and 12.18% Fixed Income.  TIAA Cref Lifestyle 2045 fund contains 54.56% Large US Company Stocks, 30.09% Large Int’l Stocks, and 10.52% Fixed Income.  And the Putnam Retire Ready 2045 Fund contains 45.09% US Large Co Stocks, 14.98% Large Int’l Stocks, and 39.93% Fixed Income (oddly quite high).  Now, what do all of these funds have in common, or should I say all lack?  You will notice that each of these funds have very small amounts of Small Co stock (domestic and foreign) or have none at all.  All three fail the diversification test in my view.  I can go on at length about how this is poor diversification, but that is an entirely different article.  The only reason that these funds performed well in the short-term past (3 years, very short term!), is that most of their assets were in the BEST performing asset class over that time: The S&P 500 Index, or US Large Company Stock.  They guessed, and got lucky.  That was the big secret.  It is not because they are a good solution for investors.  These funds will go whichever way the S&P 500 Index goes.  Just another example of how investors must be diligent against misleading information.

Beware the Imitators

The other day while driving in to work I was listening to the local sports station. Every morning, as part of their advertising, they have a local business come on for a scripted interview with the business owner or sales manager– essentially a 3 minute commercial.  On this station it is usually the local Toyota dealership, or a particular local financial advisor.


I do take some interest in what our competition is talking about, so I paid particular attention when I knew it was going to be the financial advisor. Much to my surprise the advisor started to talk about “beta”.  Beta is a term from the world of finance, and actually is used in a very influential and basic model that is meant to explain the movement of securities prices and expected return.  I was surprised to hear the advisor talk about something scientific in nature.  But I was equally surprised to hear what came after.


While it was nice to hear an advisor talk about something based in science, the problem was he was just plain WRONG in his explanation- or at least very incomplete. He said that BETA was a measurement of how volatile a portfolio, fund or stock was.  So, the market he said, has a beta of 1 (that is right).  If you had a beta of more than one, your portfolio was “more volatile” than the market.  And if the portfolio had a beta of less than one, it implied it had less volatility.


Unfortunately this is the wrong definition. Beta is a measurement of correlation and risk as it relates to the market. It explains the movement of a portfolio in relation to the market, and is used to calculate an expected return.  If a portfolio has a beta of 1, it just means it is the market’s mirror image (moving in lockstep with it), and does, by default, have a volatility equal to the market’s.  But let’s say a portfolio has a beta of zero?  Does that mean no volatility?  Not at all.  It just means that there is no discernable correlation or link between the return of the portfolio and the return of the market.  Or in other words, it means that the return of the market will not affect the return of your particular portfolio- they move independently.  His definition is especially wrong when you look at negative betas.  Does a beta of negative one mean that there is “negative” volatility or no volatility?  No.  That simply means that the portfolio tends to behave the exact opposite direction of the market.  Its volatility could be exactly the same.  Standard Deviation would have been a better fitting concept if you want to measure volatility.  A portfolio with a 0 beta or negative beta could still be very volatile.


Advisors will use any number of smart sounding terms to try to prove their knowledge or savvy. It is hard for individuals to decipher what is accurate and what is not.  (My wife even said, really Jeremy? Who would be able to tell that he was wrong??).  That is an unfortunate problem.  But this is a good example of the importance of your own due diligence.  Just because an advisor uses fancy words doesn’t mean they are using it correctly.  Do your own homework to see if there is actual substance and knowledge behind the words used.


Taking Stock


This week sure has been a wild one! It has been some time since we have had this kind of volatility, so it has come as a shock to some. Let’s look at the triggering event for this volatility, and what relevance it has to long term investors.

The Chinese stock market has not been strong lately. Below is a chart of the Shanghai Composite (curtesy of CNN Money). Notice how volatile their market is. This is because their market is largely dominated by individual investors (retail investors). Little investors like me and you. Contrast that with the US Market (S&P 500 index in the chart) which is largely dominated by institutional investors. Notice how much of a run up there was before this crash; almost a tripling of value. There are two major forces that always drive markets: fear and greed.   This is clearly and example of the later.


The volatility in the Chinese stock market has had spillover effects into other global stock markets, at least in the immediate term. It is a globally connected world today, so this is not to be unexpected. But it is important to take an assessent of what markets have done as a whole year to date and see if that is in any way out of the ordinary.

As of 8/25 the S&P 500 (large US stocks) are down about 8% year to date. International stocks as a group have actually done better, down about 6% (as measured by the MSCI ACWI ex US). The point being, none of those numbers are in fact, unusual. How many years, on average are negative in the US Market vs positive?  One in 10? One in 6? Well, going back to 1900 it has about one in every four years. If you are going to be a successful long term investor, you have to accept that 3 steps forward, one step back is an inevitable and expectable part of the process. Because the media is very interested in selling fear, they will sensationalize what is going on, and try to paint the direst picture possible. Don’t be fooled. Bad investment decisions are made in the heat of the moment. Remaining grounded, calm, and sticking to the plan are the keys to long term success.

Investor Patience

Watching the Grass Grow.

Watching Paint Dry.

Waiting for a Pot of Water to Boil.

Long Term Investing.

Some things in life take a lot of patience.

For many long term, diversified investors, it wasn’t too concerning that 2014 was a relatively flat year. After all, most people can understand that the market doesn’t always go up- and flat feels better than down. However, some investors may be getting to feel a bit squeamish that 2015 is playing out in the same fashion- or perhaps going in downward direction in light of the most recent moves.

Have you ever heard the saying “there is nothing new under the sun?” Well, the same can be said of the markets. All manner of market behavior has been, and will be, experienced in the future. Bull markets, bear markets, and yes, flat markets. The only alternative is that view is that this market correction is indeed the end of days (and in that case, the value of your IRA will soon be irrelevant). I personally don’t believe that this is the case.

We don’t have to look too far back to see examples of time periods where portfolio values did not make progress. If I look at the GIPS audited returns from one of the managers we follow, their long term growth portfolio essentially broke even from March of 1998 through March of 2003. That is five years of ups and downs, but with no overall progress. Even more recently we can see the same thing from early 2006 until the third quarter of 2011- over a 5 year period.  Investor gains are not made evenly over time.  They are made sporadically and quickly, with no discernible pattern.   Investors run into problems when they become frustrated– or scared and sell out or change strategies. When the next market uptick occurs, they are left on the sidelines and do not participate in the gains. Market corrections are in a way transfers of wealth from those you cannot hold on, to those who are disciplined and instead see opportunity.

Disciplined investor behavior is the biggest factor in determining your investing success. If you are not a client of ours, is your advisor talking to you about market volatility, or providing monthly educational opportunities? If not, perhaps it’s time to fire your broker, and hire a financial coach.

What is an Average Return?

Our July class will focus on expectations. It’s important to have realistic and rational expectations about the performance of portfolios. Without realistic expectations, investors may be easily convinced to abandon a solid long term plan after only a short period of low performance. Or, they may form too lofty of expectations after periods of very strong performance.

One of the ways investors can become confused is by the use of average returns; with the expectation that most years are close to average.

In the real world however, we rarely ever experience an “average” year.

Here is an example. If we look at the 1993-2013 performance of Matson Money’s Long Term Growth portfolio, gross of fees, the arithmetic average annual return was 9.93%. (Keep in mind ¼ of the portfolio is not in stocks). But looking back at these years, how many actual years had a 9% return? The answer: Just one. 1997 with a return of 9.86%. What if we include years where the return was either 8, 9, or 10%? In that case we have 1997, and 2005 (with a return of 10.27%). So, out of the 21 years, only 2 were near average. But this next statistic should surprise you. Out of those 21 years, how many years had a return of under 5% or over 11%? The answer: 17! Most of the years were not even close to average. Since that is the case, investors must be weary of looking too closely at short term performance (either low OR high), to create expectations of long run returns. “Average” returns are the result of a combination of very low and high performing years, not consistent repetition of the same returns year over year.

We hope to see you in class over the next coming months.

Breaking Investor Mediocraty

I wanted to give some reflection on my experiences this week as a presenter at a local financial literacy/education event.  I have been presenting in this program for several years, and year after year I do tend to see the same faces.  The audience is predominantly made up of very educated and accomplished individuals.  While presenting at this event is enjoyable, it has taken a lot of work to prepare for. 

If we look at the Dalbar QAIB study (a study that looks at investor behavior and returns), the state of the average investor is, well, sad.  Over the past 20 years, they calculate that the average investor has made less than half the return of the S&P 500.  So, even in my classes of highly educated people, there are probably some attendees that have done great, the other half have likely preformed poorly. (However, they would not admit to this).  Education and earning ability has no bearing on your investment success.

Making a change in one’s investments is a huge undertaking, both mentally and even emotionally.  All sorts of emotions come into play.  Below are a few issues that may be present in they way you are currently invested. These issues keep many investors trapped in mediocrity.

1) You are not diversified.  True diversification is rare.  And unless you can quantify it, you can’t prove you are. Can you?

2) You use active management.  This flawed philosophy has been debunked by academia.  If you are not a stock picker, your mutual fund manager probably is. Have you decided on what your Investment Philosophy is?

3) You are not disciplined.  Most investors are not. This is not a flaw! It’s part of the human condition. An advisor can help keep you focused.

4) You are taking more risk than you realize.  Unless you can tell me the standard deviation of your portfolio, you don’t even know how much risk you are taking!

5) You don’t know your costs.  You have no idea what you are paying in the form of fees, commissions, or opportunity costs.

6) You don’t know anything about the subject.  You lack even basic knowledge of investing, and are perfect prey for salesmen and women of financial “products”.  OR this lack of knowledge paralyses you from making ANY decisions. We believe an educated investor will always fare best in the end.

7) You don’t even know if you are succeeding or failing.  You don’t even know what you should be earning.  In your simple system, a positive year is a success, and a negative year is a failure.  You are failing more than you know.

If you are ready, or thinking about making a change, there are always reasons why people don’t.

1) Your current advisor is your friend.  I get that.  If you choose relationships over results that is your choice.

2) Being penny wise and pound foolish.  You think that fees are the end all and be all of successful investing.  While important, I can show you a very bad, very cheap portfolio. Cheap isn’t always everything.

3) You lack the will to make the change. You don’t have the energy to look into the situation. I know. Life can be exhausting.

4) You don’t know who to trust.  That being said, you just remain in frozen in your current state. Thankfully, there are some things we believe you can look for in an advisor to narrow down the search.

5) You have given up on the whole investing thing.  Too much money lost; and you are not playing the game anymore. While tragic, the crashes of 02 and 08 really took it’s toll on some investors.

Do these lists resonate at all with you? While a good advisor can be a tremendous asset, ultimately your investment success is dependent on no one else but you.