Target date funds are designed to be the default investment in defined contribution plans. Still, many participants combine them with other investments. Turns out these investors — especially older ones — have more aggressive portfolios versus participants who stick to the pre-selected fund only.
In an interview with ThinkAdvisor, David Blanchett, head of retirement research for Morningstar Investment Management and clearly no fan of TDF mixed investing, discusses the issue and his working paper about it, which he subtitled “Is There a Method to the Madness?”
Most of the more than $1.7 trillion in TDFs (as reported in Morningstar’s 2019 Target-Date Fund Landscape) are in passive funds. But, argues Blanchett in the interview, “there is no such thing as a truly passive target date fund.”
Winner of best-research paper awards from the Certified Financial Planner Board of Standards and the Academy of Financial Services, among others, Blanchett, for his mixed TDF paper, studied the allocation decisions of 30,516 mixed target date fund investors to see the characteristics of people who are more susceptible to mixing TDFs and how they mix them.
These investors, he found, build portfolios with allocations that make them more aggressive, “overwhelmingly” combining the TDF with equity funds. Indeed, the mixed TDF investors, on average, have a 49% exposure to equity funds, he writes.
In the interview, the adjunct professor of wealth management at The American College talks about the biggest pitfall to TDFs and offers his long-term forecast for the so-called one-for-all investment.
ThinkAdvisor recently interviewed Blanchett, who was on the phone from his office in Lexington, Kentucky. Before joining Morningstar, the Ph.D. was director of consulting and investment research for the Retirement Plan Consulting Group at Unified Trust Co.
Here are highlights of our conversation:
THINKADVISOR: What’s the biggest pitfall to investing in target date funds?
DAVID BLANCHETT: TDFs are definitely an improvement over self-direction, but the biggest problem is that they lack personalization: You’re lumped into a single allocation. Typically, you get a relatively high-quality diversified portfolio, but it’s not necessarily based on [personalization].
Please discuss your working white paper, “Mixed Target-Date Fund Investors — Is There a Method to the Madness?”
I don’t like mixed TDF investing. TDFs exist to be single investment products, and the goal is to put all your money there. The minute you start combining it with [say] cash [or] emerging markets, you’re creating a self-directed investment. For the most part, mixing makes you a more aggressive investor. If you think that a 20%/30% [exposure] is quote-unquote too conservative, then buy the 20%/60% fund.
How can financial advisors help with TDF investing ?
If you have a financial advisor, they can help you figure out the right portfolio for you — that’s the job of the advisor. The optimal strategy for [401(k) plan] participants would be meeting with an advisor every year or two and creating a personalized investing strategy. But that isn’t economically feasible; there’s no way a plan can pay for that.
What about advice for these investors down the road?
Right now, most Americans have relatively small balances. A target date fund might be the best place for them today, but as their situation changes and they accumulate wealth, hopefully, they’ll have a financial advisor who can help them figure out how they should be invested in their 401(k) plan or other plan.
I recently interviewed another expert who believes that investors should take more risk when they’re older and less when they’re younger. That’s opposite to the TDF strategy. What do you say?
I’ve seen research that talks about that. There are different perspectives. I believe that someone should become more conservative as they approach retirement. If the market drops by 40%, which it did in 2008, that’s OK if you’re 30 years old because you’ve got 35 more years to work. But if you have a very aggressive portfolio just before you retire and the market goes down like that, you’re in trouble. You can’t make it back. To be fair, though, in the past even certain target date funds haven’t been very low-risk as [investors] approach retirement. They still held risky assets.