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Portfolio > Mutual Funds > Target Date Funds

Retirement Pros Hit Back at Study Finding Target Date Fund Flaws

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What You Need to Know

  • A recent working paper found TDFs had suboptimal results for most investors.
  • TDFs may need more scrutiny but can help investment outcomes for many people, Benz said.

Do target date funds need to be rethought? The Wall Street Journal this week reported on a recent study, circulated by the National Bureau of Economic Research, that argued that the funds produce suboptimal results for most investors.

In the working paper, the authors found that TDFs’ equity allocation in retirement was too low for most retirees.

Further, the authors stated that TDFs don’t take into account that two investors of similar age may have radically different retirement situations and need different portfolio allocations. Indeed, these differences could lead to a loss of 1.7% to 2.8% of purchasing power each year.

The Journal story and study prompted Christine Benz, personal finance director of Morningstar, to tweet:

“Sigh. I’m not saying TD funds don’t deserve scrutiny, but I can think of about 10,000 aspects of the finserv industry that are more worthy of criticism. These funds really simplify things/improve outcomes for a lot of people.”

The tweet brought on an array of responses from across the retirement and financial advisor spectrum, with most echoing Benz’s support of TDFs.

Said Michael Finke, professor at The American College of Financial Services:

“I just read through the manuscript and the methods seem pretty obtuse. One aspect they don’t consider that @davidmblanchett and I have found from using @MorningstarInc risk tolerance assessments is that people get more risk-averse as they get older @SSRN

The authors of the research paper developed a machine-learning algorithm to solve for the optimal portfolio choices using a life cycle model.

Brian Allen @RetireAdviser1 noted:

“TDFs are under intense criticism because advisers want to sell managed accounts. It’s that simple. I have no doubt that the result will be higher fees and lower net returns for #401k participants.”

Benz responded:

“I agree that there is often an ulterior motive in undermining them. And the problem is, the criticism sticks. People with little financial knowledge might come into the 401(k) allocation decision with the idea that these products are suspect and proceed to make kooky allocations.”

Jeff Ptak, who co-hosts the podcast The Long View with Benz, wrote:

“This seems typical of a lot of the academic research I’ve seen on TDFs which is wouldacouldashoulda’/loses the forest for the trees. When people seek optimal or even ‘above average’ they so often get below average or worse; it is classic pushing on the string.”

Joseph Tomlinson pointed out some weaknesses in the study and the Journal report on it:

“Did they take Social Security into account? Did they just assume historical returns for stocks and bonds? Did they consider essential versus discretionary spending, and spending patterns during retirement?”

Tom Hayes stated:

“Far better than the alternative as well, which is individuals having to allocate their own qualified plan assets.”

To which Benz responded:

“Exactly! And often using 1-year and 5-year returns to do so.”

Some users, including Shawna Ohm, weren’t big fans of the products.

“My TDF when I was 23 had me in like 40% bonds. In 2009. I have never forgiven TDFs for that.”

To which Benz replied:

“Yikes, that sounds like an unfortunate outlier. The typical TDF for 2065+ (i.e., geared to people in their 20s) has about 93% in stocks. Asset flows have strongly favored better, low-cost series.”

In a Twitter thread in September, Creative Planning founder Peter Mallouk called the funds “a terrible choice for most people.”

One of the authors of the study, MIT professor Jonathan Parker, told the Journal he hoped readers wouldn’t see the study as a dismissal of target date funds but that “we can do a lot better. It can’t be optimal to be average.”


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