Recent research by investment firms AB (formerly Alliance-Bernstein) and Compass Investors shows the performance of many target-date funds are severely lacking. In fact, the returns during the funds’ critical “glide path” period were downright pitiful. They believe that the poor results were largely due to the inflexibility of the funds’ structure. What makes these findings really bad is the fact that now many companies automatically enroll their employees into their 401(k) plan and put them right into a target-date fund.
The idea behind these funds is sound: as we grow older, our approach to investing should adapt to reflect our changing risk tolerance and investment goals. The fund’s manager adjusts exposure to stocks and bonds as the investor ages, changing the asset allocations and reducing the risk exposure. All an investor has to do is decide when he or she will likely retire, choose that year’s target-date fund and forget about it.
The study’s results, however, should make us think twice about using a “one-size-fits-all” investment model. Common sense should tell us the same thing: there are far too many variables in life for one model to fit so many people. None of us has a crystal ball.
Is there a better way? Yes, there is. With a little hands-on effort, investors can make their own target-date funds and tailor them to meet their specific needs… even when those needs change. These customized funds will be more responsive, more flexible and therefore much more powerful than the “one-size-fits-all” models.
All that is needed to make a custom target-date fund is a handful of index funds and a simple age-based asset allocation method. Set up the fund, monitor it occasionally and rebalance when necessary. It can be done within an investor’s 401(k) or IRA plan, usually with cheaper fees and expenses.
The flexibility of these “homemade” funds gives investors control in adjusting their portfolios to reflect changes in:
– their life style/unexpected life events
– market conditions/investment choices
– their expected retirement date/other job opportunities
While this method does require a bit more effort on the part of the investor, the time commitment is minimal. Once set up, the fund need only be monitored once a month or less – no more often than any other long-term investment. Better performance, cheaper costs and more control: these are three great reasons that making your own target-date fund is well worth that effort.