Against Target Date Funds (Part 4)

I want to wrap up this blog mini-series on target date funds (TDF) by going back to the initial question: why TDFs?

I found the following on a robo-advisor website in the comments section of a blog post:

     > So, back to the subject at hand. I love the article,
     > and the ideas are great, but the closet quant would
     > like to see some numbers…

The author’s response:

     > Thank you for your comment… the key here isn’t
     > focusing on returns, per se – both [your TDF] and
     > [our product] invest passively. We are both trying
     > to track the index, not create active alpha.

Indeed, each TDF component aims to track its index, which is what so many financial products strive to do. The industry conditions us to be happy with this by making a strong case that it is difficult to achieve.

Articles deprecating actively managed funds are easy to find. I did an internet search for “what percentage of money managers beat the market.” I found one article citing S&P Dow Jones as reporting 86% of active large-cap fund managers did not beat their benchmarks in the previous year. Another article, also citing S&P Dow Jones, says out of 715 mutual funds that performed in the top 25% over 12 months ending in 2010, only TWO remained in the top 25% for each of the four succeeding 12-month periods.

Passively managed funds also fail to match the benchmark because of the fees. Think about it. These funds aim to track the indices or overall market. They advertise low fees (“expense ratios”) compared to actively managed funds. If the best they do without fees is match the benchmark, though, then they always lose to the index after fees regardless of how small those fees are.

Given how difficult it seems to match the market (not to mention beat it), I think people who do feel they have stumbled upon some sort of “Holy Grail.”

I believe this is all a distraction. My goal is not to beat the market, which wins some years and loses [big] in others. My goal is to pay the bills. I want consistency and I think when we strip away the ego that surrounds issues of money for so many people, they would also admit to dreaming of a linear positive-sloping equity curve.

I would argue the best way to achieve this all-important goal of consistency is with options rather than stock: something the financial industry spends too little time discussing.