#428 - Target Date Funds Are A Scam & Here's Why

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Nov 24, 20184m
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#428 - Target Date Funds Are A Scam & Here's Why
Nov 24 '184m
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Hey everyone. This is Kirk here again from Option Alpha and welcome back to the daily call. Today, we're going to be talking about why target date funds are a scam and I want to explain the reasoning behind that. The reason that I say target date funds are a scam is because what target date funds do in theory sounds rational and logical. They’re going to basically rebalance your portfolio on an ongoing basis as you approach some target date, potentially retirement, potentially the end of your employment of some target date in the future. For example, when my wife was a teacher and signed up for her benefits package, one of the things that the person who was suggesting benefits for her said, “You need to put yourself into one of these target date funds because you’re going to be retiring in 30 years, so when you retire in 30 years, (or 20 years, whatever it was) you’re going to want a different mix in your portfolio.” And again, this sounds logical and reasonable that that would happen. Her target date fund would start investing most of the capital in her account in stocks and very little into bonds and then over time, it would start to change that allocation. Maybe the initial allocation is 90% stocks and 10% bonds and then after five years, it starts to adjust down to 80% stocks and 20% bonds, etcetera, etcetera until you reach the target date.

Now, the problem with these target date funds is that they generate massive, massive fees for trading and rebalancing the portfolio and that's something that people don’t feel. You actually don't feel those fees, but they’re actually attached to practically all of these target date funds. When you get into a target date fund, although it rationally makes sense, what they’re basically doing is death by a thousand cuts. They have this ability to adjust the portfolio and remove and exit a position only because of the date, not because of some intrinsic value or some trend or momentum or quantifiable measurement as to why they should be exiting stocks and buying bonds or something like that. It's just purely a time and mechanical issue. And so, when they start exiting one position, they incur trading fees and reallocation fees and then load fees, front end load fees, backend load fees. All of these fees are just kind of wrapped up in this allocation of rebalancing the portfolio on an ongoing basis. And so, what you see is that not only do these target date funds charge an initial expense premium, but you have these underlying kind of not felt expenses through the reallocation of funds as you get closer to that target date.

It's my opinion that I don't think that people should do this. I think that target date funds are things that are going to be moving very quickly in the future to their eventual death in this industry and I think on the other hand, what people can do is just more appropriately manage their own portfolios or use an automation software to manage their own portfolios with low or no expense ETFs and then have the ability to buy and sell those low or no expense ETFs potentially in a brokerage that also charges low to no expenses as far as commissions and you can completely replicate this type of system and framework potentially on a better timing method versus just randomly buying or selling based on timeline and actually get better performance because of lower fees. Hopefully this helps out. Hopefully it helps you just reconsider potentially if you have these. I did not let my wife get put into a target date fund when she signed up for her ROTH 403B as a teacher. I was not definitely going to let that happen. But it was a good pitch by him and I wanted to talk about it here. Hopefully this helps out. As always, if you guys have any questions, let me know and until next time, happy trading.

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