History Repeats Itself

Some mutual funds are being sold as the ultimate answer as to how to invest your future retirement assets. This has been the case with target-date funds, which I first wrote about during the last bear market in 2002 in an article titled “Do Lifestyle Funds Provide Greater Security?

The problem I had with Lifestyle funds then is that they are misleading the public into thinking that they are “safe” investments no matter what the market does. People are being lulled into a false sense of security. Apparently, my concerns from 6 years ago are still valid today as MarketWatch reports in “No time to lose:”

If you were expecting your target-date retirement funds to keep your nest egg on track, you’ve been off target this year. Some of these investments have saddled shareholders with stiff losses, and probably no one feels more on edge than investors in their 60s who intend to stop working in a couple of years.

Better make that “intended.” Target-date funds geared to a 2010 retirement had lost 27% on average for the year through Dec. 11, according to fund-tracker Lipper Inc. That’s painful enough for someone nearing retirement, but investors in the most aggressive of these portfolios have seen one-third or more of their savings evaporate — stripping the shine off their golden years and possibly forcing them to work longer. Shareholders of more conservative 2010 funds have fared relatively better, down 25% or less.

Target-date retirement funds have been billed as “set-it and forget-it” investments. These one-stop shops blend a fund company’s stock and bond offerings into a single all-purpose portfolio. Allocation to stocks and bonds is automatically rebalanced over time, and the fund is supposed to ratchet down risk gradually as retirement nears.

Target-date funds have proved enormously popular with retirement savers, and the U.S. Department of Labor has even green-lighted them as “qualified default investment alternatives” for 401(k) plans.

Yet a crucial shift in the design of some of these funds has profoundly impacted investors’ fortunes in the bear market.

A couple of years ago, leading providers boosted the equity portion of these portfolios and decided to hold this stock-heavy line well into people’s retirement years.

The strategy is rooted in the belief that retirees should have substantial amounts of money in stocks to get through old age and not outlive their money. The average 2010 target-date fund had about 48% of assets in stocks at the end of September, according to consulting group Financial Research Corp.

Fidelity isn’t the only leading fund company to have reworked its target-date funds. Vanguard Group increased stock allocations, also in 2006, while T. Rowe Price Group Inc. has always channeled more to stocks in its retirement-oriented funds than its peers.

“We think in terms of long time periods,” said Jerome Clark, manager of T. Rowe Price’s retirement funds. “The vast majority in our modeling of the outcomes are going to be better served by a higher equity, growth-oriented approach.”

But this answer to so-called longevity risk has been costly in the bear market. The alterations that were made during a more bullish time have added to target-date funds’ troubles as the market melted down.

T. Rowe Price Retirement 2010 Fund, for example, commits about 57% of assets to stocks; it’s down 29% so far this year.

Fidelity Freedom 2010 Fund, meanwhile, keeps 47% of its portfolio in stocks and has lost 28%, while Vanguard Target Retirement 2010 Fund, with 54% in stocks, is off 23%.

The longevity argument also doesn’t fully account for investors who can’t handle gut-wrenching volatility, particularly with retirement in sight.

“There are funds on the edge in terms of their asset allocation that have lost a pretty large amount for someone close to retirement,” said Greg Carlson, a fund analyst at investment researcher Morningstar Inc. “We’ve been wary of funds like that.”

Oppenheimer Transition 2010 Fund is a prime example. The portfolio recently had 65% of assets in U.S. and international stocks, with 30% in bonds and about 5% in cash. The fund’s Class A shares are down 44% for the year, according to Morningstar.

Alliance Bernstein 2010 Retirement Strategy Fund is another stock-heavy offering, with 65% in equities, 32% in bonds and 3% in cash. Investors in its Class A shares have been hit with a 36% loss year-to-date.

Other target-date funds where shareholders have suffered above-average declines include John Hancock2 Lifecycle 2010 Fund, down 33% year-to-date, Principal LifeTime 2010 Fund, off 37%, and Putnam Retirement Ready 2010, down 30%.

Of course, there’s no way for investors to undo the damage of the past year. But the bear market proves that people close to retirement especially have to be proactive about stock-heavy target-date funds and take a hard look at whether or not they should continue to invest in them or find a more palatable alternative.

“Equities don’t guarantee anything,” said Zvi Bodie, a professor of Finance and Economics at Boston University. “The problem with target-date funds is they are designed to let people sit back and not have to worry. If you’re told that is the proposition, you’re going to assume you’re not exposed to any significant risk — and yet you are.”

The investment insanity simple continues on. To hold a bullish investment, no matter how safe it may appear, in a bear market is simply asking for trouble. While some target funds may have lost slightly less than your typically diversified portfolio, it still represents a severe loss to a segment of the population (heading towards retirement) that had not counted on any losses.

Sadly, many will pay a price for this ignorance. As one investor remarked “I finally figured out a plan that allows me to safely retire in 2032. The problem is I am 64 years old.”

The lesson is that no matter what type of investment you select, you can never let your guard down. This simply means you have to constantly be aware of the (changing) trends in the marketplace and be willing to exit your positions should they go against you by a pre-determined percentage.

In other words, those investors who don’t pay attention and continue to buy-and-hold blindly will again (as in 2002) seriously jeopardize their retirement future.

About Ulli Niemann

Ulli Niemann is the publisher of "The ETF Bully" and is a Registered Investment Advisor. Learn more
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