Against Target Date Funds (Part 1)

At the second local Fintech Meetup a couple months ago, we had a presentation by a startup company (name omitted to protect the professionals) selling target date funds (TDF). The entire presentation begged the question: why bother?

Wikipedia describes a TDF as a collective (e.g. mutual fund or collective trust fund) investment scheme offering a simple solution by gradually shifting the portfolio to a more conservative asset allocation by the target date (usually retirement).

Intended as constructive criticism, I suggested the presenter do some backtesting to demonstrate that TDFs are better than conventional vehicles.

The very next day, I read my June 2016 American Association of Individual Investors (AAII) Journal and found three discouraging references to TDFs. The first reference was an interview with Jane Bryant Quinn: a nationally known personal finance writer/commentator. She concluded the interview with:

      > I think the research shows that if you reduce
      > the amount you hold in stock—you reduce the
      > stock amount and increase the bond amount
      > every year starting at 65—that is the least
      > optimal way to make your money last for 30
      > years. At least hold steady.

I viewed this as the weakest challenge to TDFs, which decrease equity allocation over time starting from a much younger age. Quinn cautions doing this from the age of 65 onward.

James Cloonan, however, suggests in a second article that Quinn’s comments are relevant to TDFs. Cloonan is the founder and chairman of AAII. He said:

      > I hope there’s been more emphasis on keeping
      > more in stock even at older ages or closer
      > to retirement. In a recent interview in
      > the AAII Journal… Quinn amazingly started
      > to show the importance of doing this, and
      > she’s a very conservative person. She
      > pointed out that you just have an awful lot
      > of your life ahead at retirement. You have
      > to be a long-term investor if you’re going to
      > make enough to keep up with inflation.

Indeed, Cloonan is largely against the idea of TDFs. He argues the conventional belief of increasing exposure to bonds as one gets older is completely flawed:

      > One rule of thumb has been that the amount
      > you should have in stock is 100 minus your
      > age. Well, people retire at 70 these days.
      > That means only 30% of their portfolios
      > should be in stock. And they’ve got 30
      > years to go. Bonds and cash may not even
      > keep up with inflation. I think that is
      > real risk.

I will continue with the next post.