The following is an excerpt from BRETT ARENDS | September 25, 2012 | Smartmoney.com |
Some years ago, the money-management industry tried to engineer a single investment solution that could be applied to “everybody” on Main Street and came up with the idea of the “target date” mutual fund. These funds come under a variety of different names, but at heart they operate the same way. A target-date fund is a one-decision mutual fund that you can invest in over the course of your entire career.
Each fund is designed for those aiming to retire at a certain date. The fund starts with a lot of “risky” stocks, and over time it moves to “safer” bonds. The fundamental idea is that at any given moment between age 21 and age 65 you should be invested in a particular balance of assets — more stocks when you are younger, and more bonds when you are older.
The track to retirement, according to the industry jargon, is a “glidepath.”
How nice. How smooth. How secure.
Billions of dollars are invested in these target-date funds. They are today the default investment option in many 401(k) plans. Now comes Rob Arnott, the chairman of Research Affiliates and one of the handful of serious money managers in the country. In a new research paper he published yesterday, “The Glidepath Illusion,” he has blown this idea full of holes. “Shockingly,” he says, “the basic premise upon which these billions [of dollars] are invested is flawed.”
Arnott has mined data from the stock and bond markets going back to 1871 and then run simulations to see how these target-date portfolios would have worked in practice. He considered a fund that started out with 80% stocks and 20% bonds, and then adjusted gradually over an investing life of 41 years so that it ended up 80% bonds and 20% stocks. He considered an investor who invested $1,000 a year, adjusted for inflation, from the day she started work at age 22 to when she retired at 63.
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