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Why Target Date Funds Fail Investors: A $3 Trillion Delusion
Morningstar estimates that as of 2022, there is nearly $3 trillion invested in target date mutual funds. Per Morningstar: Target date strategies remain…
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Morningstar estimates that as of 2022, there is nearly $3 trillion invested in target date mutual funds. Per Morningstar: Target date strategies remain the investment vehicle of choice for retirement savers.
Whether retirement savers in target date funds know it or not, and we presume most don’t, they are mindlessly investing their wealth. The allocations between stocks and bonds in these funds are not based on risk or reward but solely on the calendar. Managing target date funds requires zero investment expertise, yet mutual fund and ETF managers rake in hundreds of millions of dollars a year in management fees.
The volatile market environment helps us appreciate why target date funds are foolish.
What Are Target Date Funds?
- Barrons estimates that approximately 42% of all retirement plan dollars are in target date funds.
- Per Investopedia, more than 75% of investors have some money in target date funds.
- The Department of Labor claims that 70% of employers use target date funds as their default investment.
Target Funds are passive mutual funds run by simple algorithms. To be frank, the word algorithm makes their investment process seem more complicated than it is.
The funds with the target dates furthest in the future are almost fully allocated to stocks with a minimal allocation to bonds. As each year passes, the funds slowly allocate away from stocks and toward bonds. The stock-bond targets for the funds are based solely on the target date.
The graphic below, courtesy of Vanguard, the world’s largest manager of target date funds, shows the “glide path” of investment allocations based on age.
Time dictates the funds’ allocation between stocks and bonds, not the traditional metrics investors use, like potential risks, rewards, and valuations.
Do You Care About Expected Returns?
Target date fund investors, by default, must believe that stocks will outperform bonds over the long haul. While such is often true, it is far from accurate over shorter or medium-term periods. Further, such a longer-term approach misses incredible short- to medium-term opportunities in stocks and bonds. Accordingly, target fund investors are sometimes making poor investments, which may not align with their investment goals.
To help appreciate these inherently flawed investment strategies, we ask two questions. In both questions, we ask you to allocate your retirement nest egg into A and B securities.
Question 1:
Security A has an expected ten-year annualized total return of 6.00% with a likely range of returns of 0% to 12%. Security B has a guaranteed annualized return of 0.75%.
Question 2:
Security A has an expected ten-year annualized return of 2.50% with a likely range of returns from 7.00% to -4.50%. Security B has a guaranteed annualized return of 5.00%.
If you favored A in the first question and B in the second, expected returns and risk probabilities matter to you.
Question 1 is based on data from March 2020, when stock valuations cheapened considerably, and bond yields were among the lowest in U.S. history.
Question 2 corresponds to the current investment environment for stocks and bonds.
Questions 1 and 2 represent recent extremes of stock and bond return expectations. More importantly, they correspond to periods when target date stock and bond allocation percentages were likely inappropriate for a decent proportion of target date fund investors.
What About Today?
Let’s go into more detail on question 2 to better appreciate the current risk-reward framework for stocks and bonds. To repeat question 2:
Security A (stocks) has an expected ten-year annualized return of 2.50% with a likely range of returns from 7.00% to -4.50%. Security B (bonds) has a guaranteed annualized return of 5.00%.
Should a 2025 target date fund be heavily invested in bonds while a 2055 fund be almost solely invested in stocks in the current environment?
The easy way to answer is by studying the graph below. It shows every monthly instance of CAPE 10 stock valuations and the following ten-year return, including dividends. The green line shows the current ten-year UST yield (4.90%), and the blue line indicates the investment-grade corporate bond yield (6.45%).
The current CAPE, as starred, is slightly over 30. The yellow box highlights each instance when CAPE was 30 or greater.
The expected annualized total return on stocks for the next ten years is 2.35%, much lower than the returns on bonds. Of all the instances in which CAPE was greater than 30, only a few of them were followed by a ten-year period in which stock returns beat Treasury bond returns. The number dwindles to one when stocks are compared to investment-grade corporate bonds.
Let’s take the analysis further and focus on maximum drawdowns when CAPE was greater than 30. The following graph shows the peak percentage drawdown from the month each CAPE valuation eclipsed 30. As it shows, skewing allocations toward bonds in environments like today allows you to preserve cash and take advantage of lower stock prices.
Ten Year Forecasts Don’t Mean Ten Year Investments
Bonds are much more likely to offer a better return over the next decade than stocks. However, and this is a big issue, markets change rapidly. In a year, we could be amid a recession with bond yields at 2% and equity valuations near normal. If so, profits on bonds should be taken, and a reallocation back toward stocks would likely be appropriate.
Target date funds will not adjust for the lopsided return probabilities. Target-date funds are blind to risk and reward. Therefore, they are indifferent to what is in the best interest of their investors.
Summary
In the current environment, 25-year-olds and 75-year-olds should have increased allocations to bonds versus stocks. In target date fund terminology, the 2025 and 2050 funds should look much more alike than they do. The Vanguard 2050 fund holds under 10% of bonds and 90% of stocks. The Vanguard 2025 fund has approximately 45% of bonds and 55% of stocks.
A blind formula dictates these percentages, not basic financial investment management rules.
Investing for the long run is thoughtful. Investing without considering risks and rewards is idiotic.
The post Why Target Date Funds Fail Investors: A $3 Trillion Delusion appeared first on RIA.
recession default bonds corporate bonds stocks etf recession
Uncategorized
One city held a mass passport-getting event
A New Orleans congressman organized a way for people to apply for their passports en masse.
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While the number of Americans who do not have a passport has dropped steadily from more than 80% in 1990 to just over 50% now, a lack of knowledge around passport requirements still keeps a significant portion of the population away from international travel.
Over the four years that passed since the start of covid-19, passport offices have also been dealing with significant backlog due to the high numbers of people who were looking to get a passport post-pandemic.
Related: Here is why it is (still) taking forever to get a passport
To deal with these concurrent issues, the U.S. State Department recently held a mass passport-getting event in the city of New Orleans. Called the "Passport Acceptance Event," the gathering was held at a local auditorium and invited residents of Louisiana’s 2nd Congressional District to complete a passport application on-site with the help of staff and government workers.
'Come apply for your passport, no appointment is required'
"Hey #LA02," Rep. Troy A. Carter Sr. (D-LA), whose office co-hosted the event alongside the city of New Orleans, wrote to his followers on Instagram (META) . "My office is providing passport services at our #PassportAcceptance event. Come apply for your passport, no appointment is required."
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The event was held on March 14 from 10 a.m. to 1 p.m. While it was designed for those who are already eligible for U.S. citizenship rather than as a way to help non-citizens with immigration questions, it helped those completing the application for the first time fill out forms and make sure they have the photographs and identity documents they need. The passport offices in New Orleans where one would normally have to bring already-completed forms have also been dealing with lines and would require one to book spots weeks in advance.
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According to Carter Sr.'s communications team, those who submitted their passport application at the event also received expedited processing of two to three weeks (according to the State Department's website, times for regular processing are currently six to eight weeks).
While Carter Sr.'s office has not released the numbers of people who applied for a passport on March 14, photos from the event show that many took advantage of the opportunity to apply for a passport in a group setting and get expedited processing.
Every couple of months, a new ranking agency puts together a list of the most and least powerful passports in the world based on factors such as visa-free travel and opportunities for cross-border business.
In January, global citizenship and financial advisory firm Arton Capital identified United Arab Emirates as having the most powerful passport in 2024. While the United States topped the list of one such ranking in 2014, worsening relations with a number of countries as well as stricter immigration rules even as other countries have taken strides to create opportunities for investors and digital nomads caused the American passport to slip in recent years.
A UAE passport grants holders visa-free or visa-on-arrival access to 180 of the world’s 198 countries (this calculation includes disputed territories such as Kosovo and Western Sahara) while Americans currently have the same access to 151 countries.
stocks pandemic covid-19 grantsUncategorized
Fast-food chain closes restaurants after Chapter 11 bankruptcy
Several major fast-food chains recently have struggled to keep restaurants open.
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Competition in the fast-food space has been brutal as operators deal with inflation, consumers who are worried about the economy and their jobs and, in recent months, the falling cost of eating at home.
Add in that many fast-food chains took on more debt during the covid pandemic and that labor costs are rising, and you have a perfect storm of problems.
It's a situation where Restaurant Brands International (QSR) has suffered as much as any company.
Related: Wendy's menu drops a fan favorite item, adds something new
Three major Burger King franchise operators filed for bankruptcy in 2023, and the chain saw hundreds of stores close. It also saw multiple Popeyes franchisees move into bankruptcy, with dozens of locations closing.
RBI also stepped in and purchased one of its key franchisees.
"Carrols is the largest Burger King franchisee in the United States today, operating 1,022 Burger King restaurants in 23 states that generated approximately $1.8 billion of system sales during the 12 months ended Sept. 30, 2023," RBI said in a news release. Carrols also owns and operates 60 Popeyes restaurants in six states."
The multichain company made the move after two of its large franchisees, Premier Kings and Meridian, saw multiple locations not purchased when they reached auction after Chapter 11 bankruptcy filings. In that case, RBI bought select locations but allowed others to close.
Image source: Chen Jianli/Xinhua via Getty
Another fast-food chain faces bankruptcy problems
Bojangles may not be as big a name as Burger King or Popeye's, but it's a popular chain with more than 800 restaurants in eight states.
"Bojangles is a Carolina-born restaurant chain specializing in craveable Southern chicken, biscuits and tea made fresh daily from real recipes, and with a friendly smile," the chain says on its website. "Founded in 1977 as a single location in Charlotte, our beloved brand continues to grow nationwide."
Like RBI, Bojangles uses a franchise model, which makes it dependent on the financial health of its operators. The company ultimately saw all its Maryland locations close due to the financial situation of one of its franchisees.
Unlike. RBI, Bojangles is not public — it was taken private by Durational Capital Management LP and Jordan Co. in 2018 — which means the company does not disclose its financial information to the public.
That makes it hard to know whether overall softness for the brand contributed to the chain seeing its five Maryland locations after a Chapter 11 bankruptcy filing.
Bojangles has a messy bankruptcy situation
Even though the locations still appear on the Bojangles website, they have been shuttered since late 2023. The locations were operated by Salim Kakakhail and Yavir Akbar Durranni. The partners operated under a variety of LLCs, including ABS Network, according to local news channel WUSA9.
The station reported that the owners face a state investigation over complaints of wage theft and fraudulent W2s. In November Durranni and ABS Network filed for bankruptcy in New Jersey, WUSA9 reported.
"Not only do former employees say these men owe them money, WUSA9 learned the former owners owe the state, too, and have over $69,000 in back property taxes."
Former employees also say that the restaurant would regularly purchase fried chicken from Popeyes and Safeway when it ran out in their stores, the station reported.
Bojangles sent the station a comment on the situation.
"The franchisee is no longer in the Bojangles system," the company said. "However, it is important to note in your coverage that franchisees are independent business owners who are licensed to operate a brand but have autonomy over many aspects of their business, including hiring employees and payroll responsibilities."
Kakakhail and Durranni did not respond to multiple requests for comment from WUSA9.
bankruptcy pandemicUncategorized
Industrial Production Increased 0.1% in February
From the Fed: Industrial Production and Capacity Utilization
Industrial production edged up 0.1 percent in February after declining 0.5 percent in January. In February, the output of manufacturing rose 0.8 percent and the index for mining climbed 2.2 p…
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Industrial production edged up 0.1 percent in February after declining 0.5 percent in January. In February, the output of manufacturing rose 0.8 percent and the index for mining climbed 2.2 percent. Both gains partly reflected recoveries from weather-related declines in January. The index for utilities fell 7.5 percent in February because of warmer-than-typical temperatures. At 102.3 percent of its 2017 average, total industrial production in February was 0.2 percent below its year-earlier level. Capacity utilization for the industrial sector remained at 78.3 percent in February, a rate that is 1.3 percentage points below its long-run (1972–2023) average.Click on graph for larger image.
emphasis added
This graph shows Capacity Utilization. This series is up from the record low set in April 2020, and above the level in February 2020 (pre-pandemic).
Capacity utilization at 78.3% is 1.3% below the average from 1972 to 2022. This was below consensus expectations.
Note: y-axis doesn't start at zero to better show the change.
The second graph shows industrial production since 1967.Industrial production increased to 102.3. This is above the pre-pandemic level.
Industrial production was above consensus expectations.
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