Posts Tagged ‘risk’

We started looking at asset allocation or target date mutual funds several years ago.  Found mostly in 529 education and 401(k) retirement plans, these funds tend to be used most by individuals that self-manage their assets. 

Target date mutual funds are designed with a glide path that adjust the equities, fixed income and cash portfolios of the funds over a period of time.  The adjustment occurs by moving more of the equity assets toward the fixed income allocation as time expires, and a fund approaches its designated end date. 

The Department of Labor determined that for 401(k) retirement plans, target date funds would be a better default investment than a stable value fund.  The decision was made just before the recession hit, causing many individuals to lose valuable assets in a fund they do not understand.  Target date funds have been included in the investment selection of retirement plans for several years, however this is the first time they are being considered as the default investment.

Likewise with many 529 education plans, many investors find it easier to place the assets in a self-contained allocation.  As a child moves up through grade school and high school, the assets are moved toward fixed income and cash.  Unfortunately the recession has devoured most of the gains, and many will fall short of their savings for education goals. 

There are almost 200 funds that have a target retirement date of 2020.  This list  includes all mutual fund companies with multiple share classes.  The number of funds are similar for each  target date fund from 2020 through 2050.  This adds to the confusion of what is suggested to be a basic investment for uninformed savers.  A target date of 2020 would suggest that you are planning to retire at age 65.  Thus, based on your current age, you would select the appropriate date fund.  For example if you are 40 years old, you may select the 2035 fund. 

If you are thinking about using target date mutual funds, there are three main points to consider:

1. Consider your other assets
2. Consider the costs
3. Consider the risk, glide path and allocation

Many investors are using these funds as the default for their investments.  These funds may be best for savers with little or few assets, because the funds provide them with a saving process to help achieve their goals — be it education or retirement savings. 

If an individual has other assets, though, these funds may only negate the allocation of their other assets – and possibly put their overall asset allocation in an unbalanced position.  You must examine all of your assets when considering using these types of mutual funds. 

These age-based funds are typically made up of the same mutual fund companies as other mutual funds.  So, for example, the T Rowe Price 2040 Fund is made of other T Rowe Price mutual funds in a percentage that will achieve an asset allocation that will assume retirement in the year 2040.  Keep in mind, however, that this adds a management fee on top of the management fee of the associated investments. 

While these so-called fund of funds simplify investing for some, they also cost more for those who may need it the most.  Add to this the commissions and sales charges, and these investments can quickly turn into a costly venture. 

Much of the alleged simplicity can be obtained by investing in separate funds with the proper allocation – and with similar adjustments as you need them. This provides you with more control over the costs and the investment allocations. 

This brings us to the glide path, which is the fund manager’s way of adjusting the investments as time expires and the final date of the fund is achieved.  The investments are moved from equities to fixed income over a period of time.  Fixed income is considered safer at a time when there is the anticipation of drawing down on the investment for its intended use, be it education or retirement. 

Each manager of the varied mutual fund companies determines their own glide path.  We compared the target date funds of 2020 for several fund companies, and found a wide variation in asset allocation not only in the same period but nearly a year later. 

Chart 1: Data as of June 30, 2008, according to company web sites. 

Chart 2: Data as of March 31, 2009, according to company web sites.

Our research considered several of the companies providing these funds.  The charts above show the asset allocations between equity, bonds, cash and other.  These charts really point out the differences in the managers’ intent to provide the largest gain by taking a bigger risk. 

In chart 1, we can see that Alliance Bernstein holds 80 percent in equities while Barclays holds only 62.2 percent.  These strategies will provide very different year-end results and possibly over time in the long run. Investors really need to consider their risk tolerance when choosing which fund is better for them. Unfortunately, these allocations are rarely considered by investors when they place assets in these funds.  Risk and reward should be a part of any decision-making process when selecting which mutual fund company to place your assets in. 

When we compare Chart 1 with Chart 2, we can see that the equity portions of the allocations with Vanguard have increased 6 percent, and yet for Barclay’s it dropped nearly 5 percent. Once again we can see that a manager’s style varies greatly with target date funds. To determine who is correct we would need a crystal ball. 

Target date funds were created to provide investors with a one-size fits all approach to investing. Place your assets in a particular fund, the thinking goes, and the managers will provide an allocation for you. 

We have provided three key reasons as to why they do not work for everyone. But also consider this: When picking a fund, it is just as important to consider the funds in which the target date fund invests. Investors almost need to evaluate the entire mutual fund company because they need to understand the costs and risks of all the managers associated with the investment. 

These are not a one size fits all investment. 

The following article by Lynn O’Shaughnessy was published in Bottom Line Secrets, a newsletter with an audience of 600,000 or so. 

Munis Get Scary

In recent months, many advisors have pointed to tax-free municipal bonds — issued by state and local governments and agencies — not only for their favorable tax status, but because their yields have been much higher than those of Treasury securities. But while today’s muni bond yields are tantalizing, financial adviser Dennis O’Brien believes that the bonds have now become too risky. It is abundantly clear that the national and global fiscal crises are going to be deep and protracted — and muni bond issuers around the country are sinking deeply into debt. California, with its catastrophic $60 billion deficit, still grabs most of the headlines, but, in fact, at least 46 states are facing budget shortfalls this year and next year.

Instead of munis, says O’Brien, now is the time to look to Treasuries once again for their low “credit risk” — the risk that the issuer will default on payments. But what about Treasuries’ low yields? A smart way to protect yourself is to establish a “ladder” of individual US Treasuries, from short-term to long-term, that will mature in staggered years. This way, you will not have much of your money locked into low yields for long. If you don’t want to bother with individual bonds, another alternative to munis is to spread your fixed-income assets among these three low-cost exchange-traded funds (ETFs)…

iShares Barclays 3-7 Treasury Bond (IEI). This intermediate-term bond fund invests almost exclusively in Treasuries. Recent price: $113.39.

iShares Barclays TIPS Bond (TIP). This ETF buys Treasury Inflation Protected Securities, which can shelter a portfolio against the ravages of inflation. Recent price: $97.47.

iShares Barclays Aggregate Bond (AGG). About 80% of the portfolio is made up of the highest-rated (AAA) corporate debt and US government and agency bonds. Recent price: $100.15.

Bottom Line interviewed Dennis O’Brien, president of Coastal Financial Advisors, a fee-only investment advisory firm in Farmingdale, New Jersey. His firm manages money for individuals, corporate retirement plans and non-profit organizations. www.coastalfa.com.

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