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Dan Otter

Merit Of Target Date Funds?

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Dan,

 

I will state it again, if a person is not willing to do their homework. If they are not willing to spend the time needed to understand how to invest and then keep track of their investments they should not be in any type of mutual fund without a professionals help. I think you are doing a great disservice if you suggest to anyone that because you are not willing to do the work needed to be able to invest for yourself, use one of these funds.

 

The vast majority of people could successfully invest for themselves as long as they are willing to put the time and effort into it. However, the vast majority of these people are not willing to do so. And they should never be advised to use a fund so they do not have to do their homework. For anyone that invests in something they do not understand for the most part will lose money. Investing in bond funds is just as complicated and difficult as investing in stock funds. One needs to understand the interest rate enviroment, the credit risk, as well as the duration risk that these funds have.

 

Now if Treasuries and Savings bonds were allowable investments inside a 403b plan then that would be an acceptable investment for the conservative investor for the fixed income portion of their portfolio. Unfortunately they are not. So, for those that want a "safe" investment bond funds are not thenaswer, nor are funds which have a large percentage of bonds either. For these people a fixed annuity is the answer.

 

Bill Mahoney

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Hey suoixonbo,

 

Good question on when the target date hits. Take a look at what T. Rowe Prices does...

 

What Happens When the Target Date is Reached?

There is some variance among vendors, but generally the fund remains open for about five years as it gradually reduces stock exposure until its allocation mirrors that of a static (fixed) retirement fund (typically a 20% stock/80% fixed investment mix). At that point the fund is rolled into a static retirement fund operated by each vendor. T. Rowe Price takes a more aggressive approach that moves investors from a 55% stock/45% fixed investment mix at target date, down to a 20% stock/80% fixed investment mix over a 30 year period. If desired an investor can choose to be transferred to a static retirement fund (40% stock/60% fixed investment mix) at any time. T. Rowe Price cites the example of a 65-year-old retiree and an 85-year-old retiree. Manager Clark believes these investors have different time horizons and should have the choice of different retirement allocation options.

 

When I spoke to Mr. Clark of T. Rowe Price he mentioned that they are focused on the 30 years after the date is reached. So when the target is hit, it is not an end.

 

Bill,

 

I absolutely agree that all investors should be willing to do their homework but again, I cite the earlier stats I mentioned regarding importance of asset allocation, unwillingness of most investors to re-allocate, the Dalbar report showing how typical investors chase performance and as a result realized a return of 2.57% and finally the fact that only 2 in 5 teachers participate in a 403(b) plan. If we can convince these 3 in 5 to do all the homework you mention then yes I am all for your suggestion. I guess I am trying to look at a more realistic solution to reach those 3 in 5 teachers and others who are not participating. I have to believe an investor starting today that contributes roughly $100 to $200 a month in a suitable target date retirement fund from the likes of Fidelity, T. Rowe Price, Vanguard and others and contributes for say 30 years, is going to be in decent shape. I also keep coming back to that the fact that the overwhelming majority of actively managed funds fail to beat the market. I realize you are talking about more conservative investments but if a teacher has a defined benefit plan are they being too conservative by investing 403(b) money solely or mostly in fixed investments? I think every investor should invest at their comfort level. But they should also understand the effects of inflation. I have spoken to many teaches about various investment strategies including the one you wisely advocate. There tends to be frustration on their part and quite honestly an unwillingess among some to take the time to manage their investments on their own. When you talk about the target date approach they appreciate the logic to it and yes, the simplicity. I have never said these funds are for everyone, but if one or two of the 3 in 5 teachers not contributing to a 403(b) at least started out with target date funds (and later became more actively involved as they educated themselves) I just have to believe they could do a whole lot worse. If we could convince them to take your approach a strong argument could be made that they would do better. On that I do not disagree. I just think we are fighting an uphill battle if we think that the majority of 403(b) investors are going to take an active approach to their investing. Perhaps we should turn the conversation to how we can increase participation and get investors to take a more active approach.

 

Dan Otter

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I was recently emailed by someone stating my numbers for the Vanguard Target fund for 2025 was not quite accurate. The numbers I was using were approximations, from looking at Vanguards website and some old Morningstar discs I had on hand. All I was trying to do was show the effect that a rising interest rate enviroment could have on even a conservatively managed fund that had a great deal of bonds invested in them.

 

Bill Mahoney

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Dan,

 

I agree with you 100% that there is a crying need to educate teachers and others that they need to save for their retirements. The answer to this problem is education, not simple solutions. We need to be teaching basic finance in our schools. We need to teach the basics of investing, insurances, and budgeting, to our high schools kids. So that as they go out on their own they understand the need to save, control debt, and take out the proper insurances to manage risk.

 

We need also to educate our current work force on these matters as well. The problem is that many are not willing to take the time from their busy lives to do so. We need to have the unions to start using some of the professional days to have a mandatory seminar on the subject of retirement planning. This is how we will increase participation in retirement plans.

 

As to your statement that the vast majority of funds do not beat the markets. This statement is a pet peeve of mine. The studies that showed this have missed the boat on a couple of major points. First, the used the entire universe of all funds. Small cap, mid cap, international, and bond funds. There is no valid comparision between the S&P 500 and these funds. Second, they took no consideration of the risk level of even the large cap domestic funds when comparing them to the index. They just used raw return numbers. So a fund that invested with only 90% of the Beta of the index yet did 95% of the return was deemed to have under performed the index. Even though on a risk reward basis, the fund did out perform the market. Which, in my opinion, is a far more important measuring stick. Third, there have been many periods where a large percentage of funds that were invested in stocks have out performed the markets for extended periods of time. Now I am not stating no one should an index fund, that is for each investor to decide for themselves after they have become properly educated. Just pointing out the error of the studies as far as I am concerned.

 

Bill Mahoney

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The CalSTRS offers a 403(b) comprised of 12 no-load funds. This seems to be a fine investment menu. In my view the Trustees should take the next step and design 4 pre-arranged portfolios comprised of the 12 funds for those participants who would like to place their investment on "automatic pilot" but do not have the self confidence to make the appropriate/suitable choice of individual funds. The pre-arranged portfolio addresses this void.

 

Peace,

Joel

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Hi guys,

Adding on to what Joel said, CalSTRS is also going to offer model portfolio's to view online and tons of other 403b related information, when it launches the 403bcompare.com website on July 1st. The idea that this is too complicated and that educators have to either spend years learning, doing their homework and tracking their investments or hiring a financial adviser is one view. I admit this is a valid point. However, the audience that needs this information is not and will probably never visit this site. Thus, the vast major of educators who do end up reading the materials and asking questions on this site are well on their way to becoming their own financial advisers.

Are the products that Dan suggest perfect? Of course not, but to “throw the baby out with the bath water” because bonds are not a good buy right now is ridiculous. Nobody knows what is going to happen in the next 20-25 years. The entire stock market, right now, is volatile. Equities are over priced and bonds are going to crash when interest rates go up. So, what else is new. To address these valid risks, one has to think long term, DCA, set up diversification and rebalance when needed are skills that educators who visit this site are ready to do.

Steve

 

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