Target Date Funds Offer False Sense of Security

Not unlike formal living room furniture and nuclear weapons, target date funds are only to be used in case of a dire emergency. Target date funds are offered as investment options within a lot of retirement plans as low risk investments but, are they? Here are some flaws of TDF’s.

For background, a Target Date Fund (TDF) is a fund that combines so-called growth investments with fixed-income investments in a mixture that is supposed to be appropriate for investors who plan to retire in a certain year. So, presumably a TDF for people planning to retire in 20 years will invest in a riskier mixture than a TDF that is structured for those planning to retire in 5. The theory being a person farther away from retirement needs the growth assumed with more aggressive investments and a person close to retirement needs safer investments that have less chance to decline in value soon before they will need those investments for income. Thus, a TDF implies this investment is all one needs in your retirement plan and, rather than you worrying about which investments to choose, the TDF supposedly does all that for you.

TDF’s are certainly better than stashing your savings in a money market funds earning next to nothing. But, aside from that, your choices are usually much better than that.

False sense of security

All TDF’s “mixtures” of investments are different and many may have you invested more aggressively than you’re comfortable with, or realize, close to retirement. A recent review of more than 40 TDF families showed the percentage of stocks in the funds designed for those retiring in the current year ranged from about 25 percent to about 75 percent. 75% in stocks months before you retire? Are you kidding me?

Target date funds give people a false sense of security that they can stop thinking about their investments altogether because the fund will take care of them. In fact, the Wall Street Journal cited a survey by Alliance Bernstein of 1,000 workers where most “mistakenly believed that using target-date funds would guarantee that their retirement income needs will be met.” Holy financial planning, Batman, that’s scary!

TDF’s only consider your date of retirement

Planning for one’s entire financial future involves many variables – your standard of living and it’s cost, your life expectancy, your family income, responsibilities to your children and, of course, the returns generated by your investments. Unfortunately, a vital flaw of target date funds is they take only one thing into consideration when choosing the investments within the fund – when their investors supposedly plan to retire.

But, what if one invests in a TDF assuming you’ll retire in the year 2030 but then, life gets in the way, and your son takes a couple of extra years to finish college and your daughter needs a little help early in her career and, lo and behold, that 2030 goal now becomes 2035? So, rather than still investing for some growth to make up for some leaner saving years, your TDF has you invested in extraordinarily safe, low-return investments because it assumes you will retire that year and should be taking less risk. This scenario may very well leave you short when it’s time to take income in retirement.

TDF’s assume you have no other investments

Depending on one’s circumstances, it’s certainly not unusual for families to have their savings invested in a variety of accounts. Traditional IRA’s, Roth IRA’s, Joint(husband and wife) accounts, each spouse with a workplace retirement plan, etc. Another real flaw with TDF’s is they naturally assume the investor has 100% of their savings in this one investment vehicle. As a result, your total portfolio may actually be taking too much risk or too little because you are essentially blind to how the TDF is invested. Let’s say you have $250,000 in a TDF in your workplace retirement plan and another $250,000 invested in an IRA – how can you be sure they are working in concert to help you achieve your goals?


We taught our kids from an early age not to hate, so I won’t write I hate TDF’s. In fact, they are much better than just allowing your savings to languish in a money market fund earning next to nothing. But, too many people choose them because they believe their decision-making ends with that one choice. As always, reaching whatever life goals you have depends on a solid financial plan supported by a well-thought out investment strategy. On their own, TDF’s offer neither.

The Stock Market is Volatile This Year: My Concerns

I love it when we’re about to experience a weather “event” – and when did a snowstorm become a snow “event”? What does that even mean? But, I digress. It’s fun to watch the competing weather forecasters on local TV: which one takes his jacket off first, which one rolls up his sleeves first, when does she announce she’ll be in the studio all night just for us? And, don’t forget, run to Kroger and get all the bread and milk your arms can carry!

During 2018 the stock market has ignited the same kind of breathless commentary from the financial press. Rising inflation, a potential impending trade war with China and others, and potential military conflicts with North Korea, Syria and Russia have sent the stock market rolling like the Banshee at King’s Island. 2017 saw the market at its most docile in more than 50 years. In fact, during the year the S&P 500 didn’t move 2% – up or down – in a day even once. This year? The market has already moved more than 2% in a day seven times! Similarly, last year the market moved at least 1% only 8 times. We’ve seen that 24 times already this year. But, even after enough head-jolting to make an astronaut sick, the S&P 500 is only down a little more than 1% for the year. Yawn.

So, why am I concerned?

Because the last 9 years has essentially been a steadily-climbing Bull market with few ups and downs and I’m not sure people are emotionally prepared for when a Bear market arrives. Notice I say when, not if. Nor are many of them invested properly to blunt the effects of a market collapse.

Let’s face it, if you’re in your early 40’s you probably didn’t really feel the impact of the 2008 market collapse of 40% because you probably didn’t have that much invested then. So, it’s natural to assume that this investing thing is really quite easy. You automatically save through your workplace retirement plan – a 401(k) or a 403(b) – and watch it grow each quarter. Hey, I’m good at this!

Similarly, if you’re in your late 50’s or early 60’s and contemplating retirement, you probably do remember the 2008 collapse but now a decline of your savings of 40% might materially change your retirement plans. Are you invested properly for that?

Here is why this matters:

To use a round number, if you have $100,000 invested in funds that move with the stock market, a decline of 10% will reduce your investments by $10,000 to $90,000. However, after that happens the market must increase by 11.1% to get back to your original $100,000 – a 10% increase, or $9,000, won’t do it. Ergo, in the long run one will be better off if their portfolio doesn’t experience the full swings of the market but, instead, charts a smoother path.

So, what to do:

1. Diversify your portfolio. I know, you saw this coming. But, hear me out. You might be surprised to learn that many people believe diversification means having funds in different accounts. Their thinking may be that if their IRA declines, their 401(k) might not. That’s not diversification. Your portfolio is comprised of all your investment assets, wherever they may be held. True diversification, then, means holding some in mutual funds that invest in companies within the stock market and others in investments separate from the market, such as bonds.

Now, this is more difficult than it sounds. While your ultimate goal is to invest in some funds that zig when the market zags, how much should you put in each? Some experts believe that 70% of a portfolio’s performance depends on this asset allocation – how much is invested in stock funds versus bond funds, real estate, or international funds. At Moneywatch, we spend a lot of time analyzing the funds we recommend and how correlated they are to each other.

Overall, how your portfolio is constructed depends on your age, circumstances and personal goals and should support your financial plan.

2. Review your portfolio periodically and rebalance if necessary. Review the performance of your individual investments at least annually and compare their performance to their benchmarks. Don’t just select them once and forget them. Then, look at your entire portfolio again as a whole to evaluate whether each asset class – stock mutual funds, bond funds, etc. – is invested as a share of your portfolio the way you intend. As valuations fluctuate this asset allocation tends to get out of whack and you may be taking on too much risk when the market climbs or not enough when it has declined.

3. Finally, don’t panic or overreact. The financial media live for market volatility because it gives them something to talk about. Sell this or buy that is their equivalent of telling you to buy bread and milk. If your portfolio is properly structured to support your financial plan then it’s also built to weather the inevitable storms. If that’s the case, blow off CNBC and watch Homeland, much more entertaining anyway.

If you haven’t really looked at your portfolio as a whole – all your investment accounts – now is a good time to do that. You never know when that extra bread and milk will help you through the storm.


I Spoke to a UK Investing Class: Thoughts From the Students

Eric Monday, UK’s Executive VP for Finance, is one of the brightest people I have ever known but he had a brief lapse in judgment when he recently asked me to speak to his class titled, “Personal Investing and Financial Planning.” This is a class for non-Business majors who are interested in learning about financial planning, decision making and investing activities. They discuss and learn about stocks and bonds, 401(k)’s, IRA’s, insurance and many topics most of the population never learns or even considers. Dr. Monday asked me to speak to the class about my career path, particularly my experience as a client of a financial planner, then becoming one. The students were bright and engaged and here are a few of the topics we discussed and the students’ thoughts:

How to buy a car:

Their curriculum covers the basics and I described how, 25 years ago, the buyer didn’t know the cost the dealer paid for the car so could only negotiate from the sticker price downward. Now, not only can the buyer learn the invoice price of the dealer but also what other people in your area paid for the same car recently. We also discussed the merits and pitfalls of leasing a car such as penalties for excess mileage, the advantages/disadvantages of changing cars every three years or so and the difficulty in negotiating a lease because most dealers start with the monthly lease price, rather than the cost of the car. Question (paraphrased): Will we really be purchasing cars in 10 years or will everyone just use a self-driving vehicle through a ride-sharing app? Uh, wow, hadn’t thought of that – next question!

What should we expect average annual investment returns to be?

I was pleasantly surprised that the initial response from the class was 7-10% annually. While many people, particularly young people, often believe the market will generate returns much higher than that, this range is actually quite reasonable and accurate. Good job.

What do you think when you hear the title, financial planner?

There were a variety of responses to this question but the answer I was expecting finally emerged – someone who sells products for a commission. Well, here was the softball I was itching to launch out of the park. While the financial services business has some bad actors – recent media stories even describe TIAA of pushing inappropriate products on their customers – what a person should search for is fee-only financial planner who acts as a fiduciary. Simply put, fee-only means the planner’s only compensation comes from you, the client. The planner receives no backdoor commissions from another entity to sell you products. A fiduciary, by law, dispenses advice solely in the client’s best interest. Period.

I only have about $1,000 to start investing, should I invest in riskier assets like penny stocks?

This was a great opportunity for us to discuss the concept of investing and what it really is. First, penny stocks are worth pennies for a reason – the companies aren’t worth more than that. Remember, when an investor buys a share of stock, she is buying a piece of that company. So, do you think that company will earn money over the next few years? Remember, investing isn’t the same thing as making a bet at Keeneland. We’re not gambling, we’re purchasing something we believe has value and will return that value to us. So, my advice? Invest that $1,000 into a low-cost, small-cap mutual fund, regularly add to it – and look forward to the returns in 10 years or more.

What is your reaction to the wild swings of the stock market over the last 10 days?

Crickets…..A good response for all of us.

Four Things To Do During A Stock Market Downturn

You have undoubtedly read and heard about the whiplash-producing stock market this week because the so-called experts at every newspaper and news channel have been talking about it incessantly. It reminds me of the breathless excitement of meteorologists prior to an anticipated snowstorm. In fact, these “experts” are about as accurate as the weather forecasters too. Part of the reason these trading days have been such a shock to many is that the markets have been so calm for so long. In fact, the market in 2017 exhibited the least volatility of any year in history. So, when we see a drop of 4% in the S&P 500 in one day, it is natural to feel some anxiety. Before you get too worked up, consider these four steps during a market downturn:

1. If you believe in your financial plan, do nothing

As long as your portfolio is structured to support your financial plan, don’t worry about it, do nothing. Your financial plan should provide you with the target you need to hit at a certain age – usually retirement age. That targeted dollar amount should be the amount of investment assets necessary to generate enough income for the rest of your life after social security and other possible income sources are considered. Your focus should be that target in that year, not your total next week.

2. Don’t panic and sell

People sometimes panic when the market jolts and they exacerbate the downturn by selling assets in response. Note this study: The S&P 500 made 9.85% per year from 1995 through 2014. If you sold your stock mutual funds and missed out on just the 10 best days during that period, that return drops to 6.1%. For example, if you began 1995 with $100,000, you would have $75,078 more at the end of 2014 by staying invested. So, don’t panic and move your money into cash.

3. Review your plan

If the volatility in the market makes you nervous, reassure yourself by checking your progress toward your goals. Look at your financial plan to make sure it is up to date, congratulate yourself on your progress so far and focus on your long-term goals. If circumstances have changed and your plan needs updating, recent events could be a good reminder to do that.

4. Manage risk by rebalancing your portfolio

Your financial plan should be supported by a portfolio that allocates a percentage to different asset classes – such as stock mutual funds, long-term income funds, international funds, possibly real estate funds – in a way that is appropriate for your individual circumstances. Reviewing your portfolio quarterly to ensure those asset classes are still allocated according to your plan is a good way to manage the risk of your portfolio and to stay on track.

If you are interested in learning more about investing for the long-term while managing volatility, resulting in a better retirement outcome, see a recent post on the importance of a diversified portfolio: Continue reading “Four Things To Do During A Stock Market Downturn”

Monica and Chandler Predict the 2018 Stock Market

2017 was an amazing year for the stock market with the S&P 500 gaining over 19%. Even more amazing was the lack of volatility in the market – the swings in prices that make your stomach lurch like the Mystic Timbers roller coaster at King’s Island. For the first time EVER, the S&P 500 did not decline more than 3% in one day for an entire year! So, with that experience, it is easy to perceive the market as less risky.

Here is my prediction: the stock market will go down….someday. It may be today, it may be next week or it may be 2 years from now, who knows? Trust me on this – no one knows. And if you learn just one thing today, let that be it. In fact, if someone tells you they know for sure run, don’t walk, the other way.

So, if we don’t know what the market will do, how do we know what to invest in? Answer: We diversify our investments so all our money isn’t tied up in the same kind of investment. We want some of our investments to zig when others zag. In investors’ parlance, we want as little correlation among our various investments as possible. Why: Because over the long haul, less volatility in our portfolios should mean better returns that will help us reach our goals sooner.

To best illustrate, let’s take another peek into the financial lives of Monica and Chandler:

Monica and Chandler are now both in their early 40’s working at steady corporate jobs. Most important, the financial plan they prepared with their financial planner sets a goal to reach “financial freedom” by age 55. At that point, they both intend to still work, but earn less income in their dream jobs: Chandler as a yoga instructor and Monica as a fishing guide.

Now, Monica listens to a financial talk show on the radio and is absolutely convinced the stock market is going down this year because it went up so much last year. Chandler, on the other hand, loves the feeling of his account going up each month and wants more, more! In fact, he wants to invest even more aggressively and thinks Bitcoin might actually get him into the yoga studio by age 50.

If they follow Monica and move their money into “safer” or less volatile types of investments, like bond funds, they risk missing out on major gains if the stock market behaves this year like last. If they follow Chandler’s instincts and decide to invest more aggressively – maybe putting almost all their investments into stock funds, for instance, they risk a large drop in the value of their portfolio if the market tanks this year. Fact: Since 1871 the market has spent 40% of all years either rising or falling more than 20%. But, remember, we never know which direction, up or down.

Here is my advice to Monica and Chandler: Ignore the noise and even your gut feelings and stay the course. Maintain a portfolio that has a mix of different types of investments. Their particular mix should be constructed to support their goal to reach financial freedom in less than 20 years.

Let’s look at a little math to support the case: To use a round number, let’s assume Monica and Chandler’s investment assets, their portfolio, totals $1 Million. If all of it is completely invested in the stock market and the market falls by 10%, the new value of their portfolio is $900,000. To recapture that loss and have $1 Million again, the market must gain 11%.

Now, if their portfolio is diversified and only 60% of their investments are in the stock market and the market declines by 10%, that portion will decrease from $600,000 to $540,000. If the other assets stay level (an unlikely scenario but it helps explain our example), their portfolio only declines to $940,000, rather than $900,000. That’s a decrease of only 6% when the market declined by 10%.

Most important, now the market only has to increase 6.4% in order to get back to their original value of $1M, instead of 11%. Monica will be that much closer to the fish now.

Diversification is important but diversifying in a way that is right for your particular situation is even better. For help designing a portfolio for your specific needs, contact us at


96% of Stocks Are Losers – How to Buy the Winners

Have you ever dreamed about going back in time? What would you do if you could? Other than telling Rick to guard Grant Hill to prevent the pass to Christian Laettner during the 1992 NCAA tournament, I would buy Apple stock. Why Apple? Because in the history of the markets since 1926, Apple has generated more profit for investors than any other American company – $1 Trillion. Hendrik Bessembinder, a name built for Pig Latin if I ever saw it, is a professor of Finance at Arizona State who has studied stock return data and concluded that most stocks aren’t good investments at all – many don’t even beat the paltry returns of one-month Treasury bills. What?

In fact, only 4% of all publicly traded companies have accounted for 100% of the net wealth earned by investors in the stock market since 1926. That means 96% of stocks are losers. Dr. Bessembinder defines net wealth as total stock returns in excess of 1-Month Treasury bills, which averaged 3.38%, so the total actual returns of Apple and these 4% are even higher than indicated.

So, all we have to do is figure out which stock will do the best over the next 20-30 years and we will be set! Or, of course, travel back in time and pick Apple – which may actually be easier to do. Dr. Bessembinder said, “In a market where most of the big gains are attributable to a few big winners that are hard to identify in advance, it makes a lot of sense to diversify to avoid the danger of omitting the big winners from your portfolio.”

Consider this: If a non-diversified portfolio has $500,000, all in U.S. stocks, and the market declines by 20%, the portfolio will decline approximately $100,000 to $400,000. If you are within a few years of retirement, that can be quite frightening. Now, in order for your investment assets to grow back to their pre-downturn amount, the stock market must gain 25% to reach their original value of $500,000. Even scarier.

But, if your portfolio is properly diversified, it shouldn’t match the ups and downs of just the U.S. stock market and it shouldn’t decline as much when the market declines.

Here is how to ensure you own the big winners over the next 20 years and are properly diversified: First, pick funds that contain a large number of stocks rather than purchasing individual stocks themselves. Second, pick funds that are attempting to generate returns by using different strategies. For instance:

Growth Funds seek to purchase stocks of companies that they believe have the potential to increase sales and earnings;
Value Funds seek to purchase stocks of companies where the current stock price doesn’t reflect the company’s value;
Small Cap Funds invest in companies with small market capitalizations;
Mid-Cap Funds invest in, you guessed it, mid-sized companies;
Large Cap Funds invest in, of course, larger companies.

Furthermore, to truly diversify a portfolio one must also invest in asset classes that aren’t closely correlated with the stock market. In other words, they zig when the market zags, and vice versa. Asset classes such as:

Long Term Income assets that are designed to generate income, not necessarily appreciate in value;
Real Estate funds that invest primarily in the stocks of real estate companies and seek growth through both capital appreciation and current income and are often a good hedge against inflation;
International funds that invest in non-U.S. companies and seek returns through the growth of those companies.

As always, your financial plan should guide your actions and your portfolio should be constructed so it supports your long-term goals. Diversifying properly will help you achieve those goals faster and with fewer ups and downs.