I am not a fan of Target Date Funds for two primary reasons. The first reason is the very real disconnect between the theory that bonds should be a part of every investors’ retirement portfolio (in the name of “safety”) yet the asset allocation is satisfied with bond funds. And, the second reason is the purely arbitrary annual “rebalancing” to make bond funds an ever increasing portion of the portfolio… by selling part of the equity portfolio without any regard for the state of either the equity markets or the fixed income market.
The first reason rests upon the fact that bond funds simply do not have the single element that makes bonds “safe.” That one element is the explicit promise that the owner of a bond will get his entire investment principal returned on a specific date. Have you ever gone into a bank looking for a certificate of deposit and the teller not tell you when it would mature?
Here is what I found. In examining a 401k plan with over 6,000 active participants and $167 million in plan assets as of 12/31/2009, I noticed that roughly $44 million was invested in Target Date Funds. There were eleven funds in total, from 2000 to 2050 in five year increments (therefore, participants ranged from 25 to 75 years of age). I was curious to see how the bond allocation was structured in an attempt to gauge the interest rate sensitivity of that part of the fund. I was looking for the average duration to see how far out the yield curve the manager had positioned the portfolio. To my surprise what caught my immediate attention was that not one of the eleven funds had Triple A rated average credit quality!
More to the point, the seven funds from 2020 through 2050 have an average credit quality below investment grade, commonly referred to as “Junk Bonds.” The four funds from 2000-2015 all have a BBB rating which, although the lowest possible investment grade rating, are described by S&P as medium class borrowers, which are satisfactory at the moment. I cannot say that makes me feel all that “safe” thank you very much.