At the end of 2022, there were over 60 million active 401(k) participants. Investing over $6.6 trillion dollars. And 59 percent of them owned a target date mutual fund. These number come from the Investment Company Institute’s 2023 fact book.
If you did not choose your own 401(k) mutual fund or funds, you own a target date mutual fund.
I have provided investment advice to individual 401(k) participants for over 25 years. But I still can’t figure out the investment management strategy of a target date mutual fund.
Is it to gain diversification in your 401(k)? Or is it to reduce risk in a 401(k)?
The biggest investment management problem I have with a 401(k) target date mutual fund is not going away. That is, what exactly is the investment management goal?
Harry Markowitz won a Nobel prize for the 60/40 portfolio. 60 percent invested in stocks and 40 percent invested in bonds. Modern Portfolio Theory. That was 71 years ago.
The financial media and mutual fund companies promote the 60/40 portfolio nonstop. As the perfect balance of risk and return. Target date mutual funds constructed around that concept.
Here is my first question. Invest 60 percent of stocks in what kind of stocks? Large, mid, or small cap? Value, growth, or blend?
Over the course of a stock market cycle, the most favored types and styles of stocks go in and out of favor. That fact does not seem to make a difference to target date mutual fund managers.
What about international stocks? And equal-weighted ETFs in a SDBA (self-directed brokerage account) in a 401(k). Nowhere in a target date mutual fund portfolio.
The 40 percent invested in bonds is an even larger concern for me. Short terms bonds carry little or no principal risk. Long-term bonds are high risk investments. When interest rates are rising like the last couple of years.
Do you buy bonds for diversification? Or to reduce the risk of owning 100% stocks in your 401(k)?
There is no way that bonds have “de-risked” your 401(k) lately. In fact, they have added to your 401(k) principal risk. So why own them?
Last, my largest concern about 401(k) target date mutual funds.
They promote 401(k) risk management. A “balanced” and “diversified” approach to 401(k) investing.
Call it any financial services buzzword you want. Target date mutual funds don’t do either one. When you don’t manage 401(k) principal risk, you actually add to 401(k) principal volatility and loss.
The Federal Reserve raising interest rates over the last few years was no surprise. Even to casual stock and bond market participants. Rising interest rates were news to target date mutual fund managers?
Diversification into bonds will limit 401(k) principal risk. Or balance your 401(k) portfolio.
That language looks good in a mutual fund description. But the last several years of personal and company-matching 401(k) contributions are at risk.
Ric Lager
A second opinion on your 401(k) target date mutual funds may be worth your time and effort. To make sure you are completely comfortable with your current risk levels. Comment below to get my attention.
Or sign up to receive a well-crafted 401(k) advice newsletter. Delivered to your LinkedIn news feed once a week.
Sign-up here.
