Jim Cramer Explains: The 3 Troubles With Target-Date Funds

Jim CramerBy Jim Cramer

It was supposed to be so easy.

Target-date funds were designed as the buy-and-forget investment, especially for retirement accounts.

Investors choose a fund with the target date of the year they will turn 65 or expect to retire.

A 43-year-old worker, for example, would buy shares in a fund with a target date near 2040. A 55-year-old would buy a 2022 fund. You get the idea.

As the target date comes closer, the fund automatically shifts from more aggressive to more conservative investments.

The promise of automatic asset allocation and diversification has prompted plan sponsors and participants to swarm to target funds (and their precursors, known as life-cycle funds).

Assets in target-date funds have jumped from $71 billion at the end of 2005 to nearly $378 billion at year-end 2011, according to Morningstar.

What's more, 72% of companies offer target funds as the default investment for workers who don't specify where they want their money to go, according to a recent survey from Towers Watson.

To be fair, target funds are probably better than defaulting to a money market fund or throwing darts to pick your 401(k) options -- something plenty of 401(k) participants do, unfortunately. But like any heavily hyped investment, these things are flawed. Extremely flawed. Let me count the ways:

Performance. Target funds weren't immune to the market chaos starting in 2008. The average 2010 target fund, for instance, lost 22% in 2008 while the average target-date funds for 2036 through 2040 lost 39%, according to Morningstar. The next two years brought healthy bounce-backs for the average target date fund in every time frame, but in 2011 the group underperformed again, with almost all funds showing losses.

Actively managed target funds are particularly susceptible to poor performance, says David O'Meara, a senior investment consultant with Towers Watson. (More than 50% of target fund assets are in actively managed funds.)

There's a simple reason why they don't do well.

"Most fund companies don't have the skill set to outperform the market in every asset class -- large-cap, small-cap, non-U.S. equities and fixed income," O'Meara explains. "It's hard enough to outperform one market benchmark, but then when you start packaging 10 or 20 managers, most organizations are going to fail to outperform."

Fees. Most target funds are basically a fund of funds, so fees add up quickly. As always, index funds will be the least costly -- Vanguard's index target funds charge 18 basis points in expenses -- but some companies charge significantly more than 1% in expenses for actively managed target funds.

These fees take a big chunk out of your nest egg. According to a recent Towers Watson white paper, the average worker making $125,000 over the course of a career who pays $20 in fees for every $10,000 invested in target-date funds would lose three years worth of retirement income to fees. The same worker who paid $100 in fees for every $10,000 invested, would lose 15 years worth of retirement income. That's a lot of cruises and greens fees going to fund companies.

The Right Target. Making sure the target funds offering in your 401(k) are right for you takes a lot more work than simply picking the date closest to your retirement year.

The way target funds are allocated among different asset classes up to and beyond your retirement varies widely. Some may keep a majority in stock, even past retirement date. Others may move to a majority in fixed income well before you retire. Still others may invest in REITs and commodities to further diversify the fund, which can be a good thing, especially if these sectors aren't represented elsewhere in your 401(k) investment menu.

The point is investors still have to do plenty of homework to make sure their default option is invested the way they want it to be. There is no such thing as buy and forget.

Because you have to manage target funds the same way you would any other investment, why not throw yourself in completely and come up with your own investment picks that offer diversification and -- one hopes -- much higher returns.

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Hes complaining about .18 expense ratio that's not bad compared to most fund companies. $20 per 10K invested buying and selling stocks at $9 per trade would take more out than if you just left it depending on the frequency of trading.

August 13 2013 at 4:18 PM Report abuse rate up rate down Reply

Jim, do you have any thoughts about controlling HFT? My answer to the question of how do High Frequency Traders harm and take advantage of public investors is a simple one. In times of uncertainty, High Frequency Traders become High Frequency Short Sellers and pound stocks (equities) down because there are no real buyers. This causes the marketplace for thousands of individual stocks (stock market) to become dysfunctional and perform like a monolithic commodity market.
The recent emergence and dominance of stock market computerized High Frequency Trading has eliminated the value of traditional methods for evaluating equity investments. Quoted share prices have become no more than the reflection of the headlines of the day. High Frequency Trading must be addressed and dealt with if individual stocks are going to remain an investment option for the public.
I believe High Frequency Trading abuses could be controlled by: (1) reinstating the up-tick rule, (2) charging a small transaction tax on every trade and (3) enforcing the rules against “naked” short selling that computer trading programs now ignore. Cliff Lindroth, San Diego, CA

June 12 2012 at 5:33 PM Report abuse rate up rate down Reply

The real trouble with finaincial advice is that smart money advice only go to certain people with sterling creditenials like CEOs, professors, glittery and famous, etc for a price.. If you are not among the so called "high heeled" crowds, you are not gonna get what you paid for or free.. Those advices are hit and miss. but there is often a few gems in them if you can choose correctly. They are just tidbits not slap on shoulder tips..

June 12 2012 at 3:55 PM Report abuse rate up rate down Reply

Cramer is a big fan of the Obama adminstration. That is enough for me. I cannot imagine anyone taking advice or wasting one minute on a guy with no more common sense than that.

June 12 2012 at 8:25 AM Report abuse +1 rate up rate down Reply
1 reply to cherofnc's comment

Right on baby! Right on, right on, right on!

June 12 2012 at 9:29 AM Report abuse +1 rate up rate down Reply
Richard Johnson

He was pretty honest in here. http://investorshangout.com/post/view?id=31564

June 12 2012 at 6:14 AM Report abuse rate up rate down Reply

Target date funds are a joke and a disaster waiting to happen as Cramer implies.
Once again, the newsest fandago investment rolled out for the masses has made sponsors alot of money but few others.
The saddest thing I have encountered is HR folks responsible for selecting the fund group and or mix of funds that administers their 401k plan couldn't tell you what a growth verses aggressive growth verse a growth and income fund will do for an employee but more importantly, they don't know enough to tell employees what markets can do TOO THEM! Whats a management fee? Front end, backend load? Whats a 12B1 fee? How do annaul fees stack up? How can a big front load fund like American Funds be one of the best despite the up front cost!? HR folks seem to knwo what vesting is but beyond that, most have no clue.
Like what is the value of dollar cost averaging? How important is it to reinvest dividends? Why? How should one be diversified?
Okay, its hard to tell an employee what they should care about especially when the person telling them knows so very little about anything when it comes to investing.
Oh and sorry but Finance and Econ degrees teach balance sheets, macro and micro but not whaty to do with that information and you can forget about knowing about how/what to invest into. The most important aspect of everyones future and so few understand whats going on when it comes to investing.

June 11 2012 at 9:27 PM Report abuse rate up rate down Reply

Cramer is an IDIOT. Follow his advise and you are broke fast. Cramer just wants to hear himself talk. Listen close if you can stand it, and he just doesn't make sense. King of double talk. Talks both sides and down the middle.

June 11 2012 at 7:05 PM Report abuse rate up rate down Reply
1 reply to rjen164497's comment

not only that, it's been reported he had conflicts of interest as well as bad advice...

June 11 2012 at 9:07 PM Report abuse rate up rate down Reply

This loud-mouthed hack Cramer, this Carival Barker bum aside; When you stand naked before The Man on judgement day (and judgement day is coming!) it ain't going to be the size of your wallet nobody is looking at.

June 11 2012 at 3:41 PM Report abuse -2 rate up rate down Reply