We've written before about "rules of thumb" and their imminently fallible future. It appears that one of the most widely used "rules of thumb" may take a dive.
I'm thinking "maybe" not because there's a mathematicians chance that this often used "rule of thumb" actually works, but I say "maybe" because it'll be interesting to see if the public ever finds out.
Target Date Funds....
Oh these are a help right. Here's the premise;
a. Lay people can't do very well picking their own investment allocations (this is something that we know to be true and is widely supported by research)
b. You can purchase or invest in a fund that will take care of all that for you, AND;
c. It will automatically adjust the percentage of stocks vs. bonds that you own as you get older so that you're experiencing the lowest risk (i.e., owning the least amount of stocks) as you get older and experiencing the highest amount of risk (i.e, owning the most amount of stocks) as you're at your youngest.
Think of it, on "auto pilot", all you've ever asked for. When you're young and your earnings are highest and you can afford the most risk....an aggressive portfolio and then, without even so much as a question or concern, an automated tilt to the conservative side of the table just as incomes drop, reliance on portfolio income increases and age sets in.
Problem is...it doesn't work, and frankly, research indicates it never did.
It was just a ruse from the mutual fund industry that you bought and paid for likely with a fair amount of your retirement nest egg, but hey, who needs more money, you or Wall Street?
Intuitively, consider the matter:
a. you start out with the smallest amount of money invested in the most profitable asset class, stocks.....
b. overtime, you accumulate more money as you move toward a lower yielding option, a blend of stocks and bonds, then....
c. you wind up with the most amount of money at the exact time that you're in the poorest yielding asset class of the bunch....bonds
Hmmmm....target dating doesn't sound quite that interesting when you explain it that way does it?
Well, once again, Wall Street's and the actively managed mutual fund industry would conveniently like to not let the "math" cloud the issue.
Here's a typical Wall Street spin you can try.........
If you're ever in an elevator that cuts loose from it's cables and starts plummeting to the ground, all you need do is to jump in the air just prior to impact to save your soul. Seems to make sense right? For 95% of the "trip" you're not even actually falling are you? I mean you're standing on the floor of a "fixed" object so a good hardy "jump" at just the right moment only puts your feet about three feet off the floor which means that if you only went up three feet, you'd only come down three feet right?
Sounds plausible. It's not. But again it sounds plausible....if you ignore the math. (P.S. if you've ever watched Myth Busters you know how the elevator story plays out.)
Bottom line is that gimmicks can get a big tailwind, especially when they're sold as something that's so obviously awesome.
But let's not forget, "bad" ideas always need to be sold.
So if you're a "target" date investor, check and make sure that the target's not on your nest egg.