How Safe Is the “Safe” Investment Among Your 401k Plan Options?
By George Huss
This article will help you see that the “safe” investment, the Target Date Fund, in your plan may be among the riskiest investments you have ever bought into.
It is my opinion that these funds are flawed by design, not only because the idea of rebalancing a portfolio on some arbitrary date with no consideration given to the state of any market whatsoever, but because there is a disconnect between the theory and execution of the need for the safety of bonds in an individual portfolio – the execution is to put the investors’ money into bond funds which is not the same product as bonds.
Bond funds have NEVER included the one element that makes bonds the “safe” investment which is a fixed date when the investor will get back one hundred percent of his investment. This is just like going to the bank and putting your money into a certificate of deposit. You and the bank agree on the date, three-month, six-months or one year in the future when the bank will give you back all of your money.
I recently finished analyzing a 401k plan with $167 million in assets and over 6,000 active participants, as of 12/31/2009 and noticed that about twenty-five cents on the dollar was invested in Target Date Funds from 2000 through 2050. I guess this should not shock me; but, it still makes me shake my head. In the process, I went to Morningstar and looked up each of these funds. I was curious to see the effective duration of the underlying fixed income portfolio trying to see where they were positioned on the yield curve and how sensitive the portfolio may be to interest rate changes (2000-2020 averaged 3.55 years and 2025-2050 averaged 4 years).
What shocked me to the core was that I also saw the average credit ratings of the portfolios. Now I had assumed, because the theory here is to provide safety to the participant by virtue of the “bond” portion of the portfolio, in the bond funds, that I would only see Triple A rated paper – the very highest rating given to investment grade bonds as designated by S&P. What I found was that NONE of these Target Date Funds has an average credit rating better than a BBB! This is the very lowest investment grade rating by S&P defined as “medium class borrowers, which are satisfactory at the moment.” The Funds dated 2000-2015 were all BBB. 2020-2040 have an average credit rating of BB and 2045 and 2050 have a single B.
Ladies and gentlemen, any rating below BBB is defined by S&P as “Non-Investment Grade (also known as junk bonds).” Excuse me?! The “safe” portion of this retirement investment option is in “junk” bonds?! I do not care how good the manager of this portfolio is in the assessing the credit quality of the investment independent of the rating agency: Is this not contrary to the theory ~ the theory that I was sold ~ the theory that I bought ~ to protect my retirement nest egg?! The interest rate risk is bad enough in a bond fund. I do not want to assume credit risk as well! Please, do not walk, run to your plan’s 401k options and plan your exit strategy out of these funds!
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