In her recent column on MarketWatch.com entitled “Companies trim investment choices in 401(k)s,” Andrea Coombes points out that many employers have been going against the long-term trend of increasing investment options within their sponsored retirement plans. Many plan participants have been unsatisfied with the performance of their retirement accounts, and employers seem to be taking action to satisfy the unease of employees – but in all likelihood will only make things worse.
In fact, over the past several years it seems that more and more employer-sponsored retirement plans have been limiting investment options to broad debt- or equity-focused funds (e.g. large cap growth, small cap value), along with the more recent additions of target-date retirement funds.
Surveying the change in landscape, it would seem that companies think they’re doing employees a favor in trying to dumb down 401(k) plans, simplifying the options available. Given more recent developments – namely the increasing dissatisfaction among plan participants – we are likely witnessing the culmination of this trend.
For a prime example of how these developments are adversely affecting investors, consider that at present the Dow Jones Industrial Average is roughly the same level it was in 1999. That certainly doesn’t mean there hasn’t been plenty of money to be made in the markets; it’s just been in certain sectors.
A growing number of plan participants have been wising up to the fact that buying and holding a broad range of stocks – essentially the market – simply isn’t a viable option.
The recent growth of popularity in target-date funds is yet another example of plan sponsors’ misplaced intentions.
Put bluntly, it’s safe to say that target-date funds miss the mark, by and large. In fact, most investors don’t even realize how these products work; though they’re assumed to be an “easy button” for investing.
Target-date funds are nothing more than an actively managed portfolio with a shifting balance between equities and bonds. While these funds always have some composition of bonds, the fixed-income allocation increases as the fund’s target date approaches.
If most of those people currently utilizing target-date funds were asked whether they wanted to put 40%+ of their portfolio in bonds, they’d probably say ‘no,’ and with good reason. It should be obvious to the investing public that right now is a terrible time to be buying ANY bonds at all, and any fixed-income portfolio will likely suffer in the near future.
A quick scan of a long-term interest rate chart will show the United States to be at the bottom of a long-term cycle, with rates having fallen since peaking in the early 1980s. The probability of rates rising in the future is exponentially higher than of staying low much longer.
As interest rates begin to rise, target-date funds – and most bond funds – will certainly see their prices suffer. These funds are priced daily, meaning that the underlying bonds they own have to be valued daily, priced to the market. As interest rates rise, the market value of those bonds will fall, pushing fund prices lower.
This is only one example of a shortcoming in target-date funds. The subject of higher expense ratios is a topic for another day. The bottom line is that employers’ recent efforts to simplify investment options in retirement plans have been counter-productive.
What’s more, plan participants have been wising up and realizing they’ve been penned into broad, ineffective strategies. For that reason it seems likely that the long-term trend of restricting focused investment options is actually coming to an end.
In the near future it seems that more and more plan sponsors, at the urging of their participants, will be forced to broaden their investment horizons; not just in the number of options but also in their variance of focus. Limiting options doesn’t make investing any easier, and retirement plans can’t be dummy-proofed.
The task at hand for plan sponsors will be to include a greater variability of sector-focused investment options, as well as providing the plan participants with more resources to help in the selection process.
Dock David Treece is a discretionary money manager with Treece Investment Advisory Corp (www.TreeceInvestments.com) and is licensed with FINRA through Treece Financial Services Corp. The above information is the express opinion of Dock David Treece and should not be construed as investment advice or used without outside verification.
