Given the severe retrenchment in asset values over the last several months, it's not surprising that near-term target-date funds ("2010" funds especially) are getting so much scrutiny these days. Our office has fielded several media inquiries on the topic, with the most common (and important) question concerning whether funds with 2010 targets have held up well enough.
So we were pleased to see Craig Israelsen's informative piece on this subject in the November issue of Financial Planning. Israelsen's central argument is that most 2010 funds--and especially the biggest 2010 funds, those provided by Fidelity, T. Rowe Price, Vanguard, and Principal, which together amount to roughly 90% of the assets invested in 2010 vehicles--feature excessive equity allocations. In fact, these four monster funds had an average equity allocation of 52.2%. (As far as we can tell, these data are through September 30, 2008. Given October's epic ugliness, Israelsen's arguments take on more significance still.)
Here's the heart of the dilemma:
What would happen if investors intended to withdraw their money at the target date and purchase annuities? Isn't it true that the glidepath (the dynamic asset allocation model that governs the portfolio from inception to the target date and beyond) is supposed to guard against exactly this sort of meltdown?
This is the question on which all thinking about target-date funds has to turn: What's the annuitization date?* As we've noted in this space on many occasions, one's retirement date is not one's financial finish line. And given current/future life expectancies, the true finish line is stretching further out across the horizon. All of which means that people at or approaching retirement might need to bear some (or even substantial) equity risk to give their assets a better chance of outliving them.
But Israelsen's argument, that target-date funds should protect soon-to-be retirees against the risk of losses of the sort we've seen in recent months, is spot-on for those who plan to transfer their longevity risk to an insurer through the purchase of an immediate annuity.
So all of this boils down to what a new retiree plans to do with his or her accumulated assets. If annuitization per se will take place soon, significant equity exposure make much less sense. If the annuitization date is more flexible or more distant, then non-trivial equity exposure makes a little more sense.
Assuming near-term annuitization, it's hard to argue with Israelsen's conclusion:
A target-date fund that fails to attenuate risk near its target date has failed in its primary purpose. Given that premise, nearly all 2010 target-date funds are failing right now. Even worse, virtually all of the target-date funds coming down the pike (2015 funds, 2020 funds, etc.) are cut from the same cloth and will likewise experience big losses near their target dates if the equity markets decline.
As ever, these questions imply no easy answers (which reminds us of Charles Lindblom's description of the human condition: "Small brain, big problems"). Whatever the number attached to a target-date fund might say, investors and their advisors simply must dig beneath the marketing language to understand the vehicle's asset allocation, its constituent funds, its expenses, and its investment policy.
Target-date funds have made things easier in many ways, but there's still no substitute for heeding that timeless warning: caveat emptor.
* A related question would concern the method of annuitization, i.e., the purchase of a immediate annuity per se or some other means of planned, systematic withdrawals from a corpus of assets.
Craig L. Israelsen, "2010, A Fund Odyssey," Financial Planning, November, 2008