TDFs: The Storm You Don’t See Coming

We have informed clients through newsletters and warned potential clients in meetings for years about long-term fixed rate debt and how investors with exposure to bonds face substantial investment risk. Unfortunately, our warnings that bonds will pose a serious threat to investors have often fallen on deaf ears, however more professionals are waking up to the danger of fixed income going forward. Readers will also recall that we have spent a great deal of time over the last several years covering Target Date Funds (TDFs) and how they might be affected by the bond market.

This week the Wall Street Journal offered some insight on bonds and TDFs. Over the last decade TDFs have become a popular investment, as they offer an “easy button” approach to retirement. In a nutshell, TDFs take an estimated date of retirement and then build an ideal portfolio for someone of that assumed age. Aside from typically being much more expensive than standard class-A share mutual funds, these funds do not account for economic conditions in their holdings.

While we hate to reiterate this point on what seems like a daily basis, we cannot stress enough the concerns that we see coming in the bond market. The Quantitative Easing policies of the Federal Reserve have made bond prices skyrocket, which in turn have lowered yields. Many investors do not realize that bonds are traded on the open market just as stocks are, and the bond market dwarfs the US equities markets. When yield rises, bond prices fall, just like a teeter-totter. When bond yields begin to rise, bond holders are going to be in for a world of hurt.

Unfortunately for TDF investors, most of these funds have a high exposure to bonds. According to the referenced article, TDFs with a target of 2015-2020 on average have anywhere from a 35%-50% exposure to the bond market. When we foresee the problems in fixed income that we do, there is no way that we could logically suggest investors expose themselves to an investment that is near an all-time high and faces substantial risk going forward.

The unfortunate part about all of this is that most brokers who are pushing these funds have a great understanding of the products that they are selling, but not the economic environement in which they are being sold. We encourage readers who are considering purchasing TDFs or already own TDFs to request a price breakdown of these funds in comparison with a standard mid-cap growth fund along with a breakdown of fund holdings. You will notice that fees in TDFs are layered, usually much higher and commissions are higher as well.

An old saying that we toss around the office is, “You don’t get hit by the truck that you see coming.” Bonds have been a safe haven for investors for so long that many refuse to accept the fact that there is serious downside risk in that sector. We only hope that investors take some time to reevaluate their holdings and are aware of what they own.

Ben Treece is a partner with Treece Investment Advisory Corp (www.TreeceInvestments.com) and licensed with FINRA (www.Finra.org) through Treece Financial Services Corp. The above information is the opinion of Ben Treece and should not be construed as investment advice or used without outside verification.
« Back to the blog.