Avoid Target Date Funds

I'm a conservative investor, coming out on the side of "wealth preservation" versus "gambling".  But I was pretty lucky when I read an article and decided that "Indexing" was for me, plowing the vast majority of my equity investments into Index funds over 20 years ago.  It has been a great wealth builder, but whether this was because of John Boggle, who came with the concept of Indexing at Vanguard, or because everyone else on the planet piled into them over the past two decades is up for debate.

One investment where I wasn't so lucky was my kid's 529 college fund.  It didn't offer much except Target Date funds.  For those of you not familiar with the concept these are funds that invest in a mix of stocks and bond FUNDS with a target date in mind (for 529 the date they would start college, for retirement funds the year you retire).  The further out the target, the more stocks funds it holds to capture a higher risk/reward over time, the closer in the date the more bond MUTUAL FUNDS it holds.

And the "MUTUAL FUNDS" part of the bond investment is the main problem with these instruments.  Bond funds are risky!  I lost $10,000 in one week in a "safe" US bond fund when the Fed raised interest rates.  Sure, people made a ton when they lowered them due to ZIRP (Zero Interest Rate Policy), but bond funds have duration risk, which means that they will move up and down with more sensitivity the longer out the bond (or group of bonds) mature.

This is a long way to say that my kid's 529 invested over 18 years in a Target Date fund was a lousy investment due to duration risk.  It basically was invested in stocks when they went down, then investment into bounds right before interest rates went up since it was on autopilot.  That is not to say it appreciated some, but it could have done a lot better either actively managed, or if it had held bonds to maturity, not "bond funds".

Holding individual bonds - never bond funds - is now what I do with my personal assets.  Lesson learned.

My personal experience is reflected in a recent Barron's article, which had me nodding the entire time.  It is behind a paywall, but basically restates my folksy experience in a more professional manner.

Some say that many target-date funds are too heavily invested in a slice of the fixed-income market—investment-grade bonds—and that can leave portfolios overexposed to U.S. interest rates. They say investors could get higher returns over time and less volatility during periods of rising rates by owning a broader mix of fixed-income assets...or being actively managed.