Over the past 26 years, target-date mutual funds have become enormously popular. Those lifecycle, age-based funds hold a mix of stocks and bonds that change as you age. Holdings are mostly in stocks for people under 55 and mostly in bonds for people over 65. The idea is that the funds supposedly become more conservative as the target date approaches.
More than 50% of 401(k) investors have all of their 401(k) assets in target-date funds and approximately 75% of other investors have at least a portion of their money in at least one target-date fund, according to an early 2020 study conducted by The Vanguard Group.
Unfortunately, these funds don’t live up to their promise of offering safe growth. A big reason for this is the funds’ fees.
But even lower-fee target date funds tend to underperform.
For example, the low-cost Vanguard Target Retirement 2015 Fund (VTXVX) gained just 6.4% on average annually from its inception in October 2003 to the end of 2020, while the S&P 500 gained 9.5% on average annually over that same period.
That means a one-time investment of $10,000 in VTXVX would have grown to just $28,708 as of December 31, 2020, while the same $10,000 invested in an S&P 500 ETF would have grown to $46,708 over that same period.
That’s not the only problem with target-date funds.
The other issue: They don’t really provide the level of safety promised. In 2008, when global stock prices fell sharply, target-date funds that were nearing their target date and were allocated heavily in “safe” investments performed very poorly.
For example, target-date funds having a target date of 2010 fell 20%, on average, in 2008. And one of those funds, the Oppenheimer Transition 2010 Fund (OTTCX), declined by a whopping 41% during 2008.
In spite of their lackluster performance, many so-called financial experts encourage people to invest in target-date mutual funds. As a result, target-date funds now have approximately $1.9 trillion in assets under management. That’s up from $158 billion in assets in 2008.
Clearly, there are better alternatives. You could invest in an index fund.
In the current environment, that means allocating approximately 95% of your investable money to equities. That’s because numerous economic indicators suggest that the economy will continue to recover after COVID.
However, there’s a good chance that mid and long-term interest rates will trend higher throughout 2021, as bond investors demand higher rates in response to huge increases in U.S. government debt. Rising lending rates are not good for stocks in general. That’s because stocks tend to fall when interest rates increase.
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