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Dan Otter

Should Every Employer Offer Target Date Funds?

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What if it a minimum every employer offered low cost (less than 50 basis points) target date retirement funds? From there employers could choose to also allow agent-sold plans and/or offer a variety of mutual funds, etc. This way every investor would have a simple low-cost option that ensures they are in a fairly decent allocation relative to their age. I realize this isn't a panacea, but would this be a reasonable request?

 

Dan Otter

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Guest Sierra

Dan,

 

The City of New York administers a 457(b) and 401(k) Deferred Compensation Plan. It offers 7 investment funds and from that lineup 9 Target Funds. Its weighted average expense ratio is about 30 basis points.

 

Peace,

Joel

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Dan,

 

Target retirement funds would be great for the following reasons.

 

1.) They would be cost effective. Fifty basis points, or less, would be a huge improvement over the current offerings in most plans.

 

2.) The advice is built into the product. Target retirement funds would automatically maintain asset allocations. These funds would also gradually alter asset allocations as the fund approaches its target retirement date. This is the simplicity many investors need. Most investors are not knowledgeable enough to know how and when to rebalance their retirement portfolios. Target retirement funds eliminate many these decision-making problems.

 

It seems that AIG Valic has seen the marketing benefit of offering a target retirement fund. Last spring they began offering their HighWater Mark funds. Obviously, Valic feels the marketing need to offer Target Retirement funds to new and current customers. What they are hoping on is that people will not find out that their funds have expense ratios of 2.4%. This is ridiculously high.

 

And the beat(ing) goes on...

 

Gerry

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It's also worth keeping in mind that funds of this kind are appropriate only until you retire. After that, your investment needs depend less on your age than on your financial ability to absorb risk, and on other factors related to your cash flow. For a lot of retirees, their "risk capacity" is close to zero -- whatever their supposed "risk tolerance" might be.

 

For that matter, when you retire, your investment portfolio's performance is no longer so critical an issue, assuming you are withdrawing funds and your balance is beginning to decline. All the pre-retirement projections that focus on rate of return are so amazing because of the effects of compound interest, and that hypothetical return you're getting in the final years is huge. In retirement, though, it no longer works that way. Your balance is going down, and your interest is being spent, not compounded. So rate of return, while not irrelevant, is not the driving force it is while you're still working. (For the same reason, fees are not as important, either.)

 

What retirees need is a comprehensive approach to their finances, of which investment strategy is probably not one of the three or four most important elements. On the contrary, the investment strategy should be subservient to the other elements of their finances.

 

Which is why I say that the life-cycle or target funds can not substitute for advice (and very good, very personalized advice at that) once people get close to retirement, and thereafter.

 

They are at best, therefore, only a partial solution.

 

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Guest Sierra

Yan; I disagree. Life cycle funds by definition are for life which includes both the accumulation and payout periods. During the payout phase about 80 percent of the portfolio is in fixed income because you are in the last phase of the cycle of life which is retirement. Your financial ability to absorb risk is while you are working and this is why during the beginning years the porfolio is predominantly in stock.

 

I am very much in favor of using these funds for generating the lion's share of one's retirement income. These no load "automatic pilot" funds are disliked, for obvious reasons, by the commissioned sales crowd. They would rather have you pay a commission and buy 6 different funds rather than 1 fund with 6 different portfolios.

 

Peace and hope,

Joel

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TR,

What exactly are Highwater Mark funds?

 

403bcompare.com:

http://www.403bcompare.com/Employee/SubProducts/SubAccounts/DetailVariable.aspx?sid=10443&pid=2300

 

AIG SunAmerica 2020 High Watermark Fund

 

"Seeks capital appreciation consistent with preservation of capital investment gains. The Fund is designed to protect from downside risk through a guarantee to return to investors on a target maturity date the highest value achieved during the Fund’s lifetime adjusted for dividends, distributions and extraordinary expenses. Seeks high total return as a secondary objective. This Subaccount was added to Portfolio Director February 18, 2005; thus, Average Annual Total Return data for December 31, 2004 is not available."

 

What kind of fund is this then? The guaranteed return is obviously not like any funds I know. Is this an equity index fund with a target retirement twist?

 

Thanks,

Gerry

 

 

 

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Guest TR1982

Gerry,

It's not a lifecycle fund. It does not try to achieve some broad diversification based on a particular date for an individuals retirement. It could be used that way but that is not it's objective.

What it does do is provide a lock in for the highest value of fund the during a specific time period. It uses S&P 500 hedging strategies along with a T-bill investment to insure that the guarantee can be provided without risk to the NAV. It is an interesting concept that could be used for a shorter period investment like a college fund or if the investor knew that they could not absorb any loss of principal during the investment period. It's a fairly sophisticated investment strategy that I confess I do not fully understand. I'm not sure if I would compare it to an EIA since I don't know the specifics of how they work.

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It works very similar to an EIA - they buy STRIPS that will much at either the principal or principal plus ""% return and invest the rest of the money in futures contracts on the S & P 500 (a non-diversified portfolio of stocks). They then charge between 1.65% - 2.30% plus trading costs against the value. It's not an especially sophisticated strategy, though they way they run the funds is not easy. I don't see the value in these funds and wouldn't recommend them.

 

I also respectfully disagree with Chuck's assesment that investment strategy is not one of the three or four most important elements in a financial plan. While investment strategy is the last item in a complete financial plan it is not by any means irrelevant, it is very important and drives nearly the entire possible outcome of your retirement. A return at or below inflation will lead to the loss of purchasing power, which is the number one goal of retirement planning - maintaining purchasing power.

 

The High Watermark funds are a gimmick, though not an entirely bad idea, they are just to expensive. I am still researching them and trying to understand them a bit more, but they aren't something I would recommend to someone.

 

ScottyD

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