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.