Many investors think that having "too much" risk isn't a big deal…
… until it hits "home."
That's the case for 6.2 million American who have invested roughly $224 billion in Fidelity's Freedom Funds and who recently found out – the hard way – just how much risk the fund managers have taken on to boost performance… arguably, without telling them.
The Freedom Funds, in case you are not familiar with 'em, are Fidelity's largest retirement fund grouping and worth more than $1 billion a year in management and fee revenue to the Boston-based financial services company.
Based on "target dates," the Freedom Funds are supposed to be a one-size, easy-to-use investment that diversifies investments and automatically manages risks by reducing them as fund participants age.
When you're young, for example, you might choose the Fidelity Freedom 2060 Fund as a way to set it and forget it for the next 42 years. Somebody only two years away from retirement, by contrast, may opt for the Fidelity Freedom 2020 Fund.
The appeal is terrific.
Over time you're supposed to get great performance and decreasing volatility – risk by any other name – that ensures your hard-earned retirement funds will be there when it's time to call it quits.
Hence, the "targeted date" moniker.
Three Reasons I'm Not a Fan of Target Date Funds – and You Shouldn't Be Either
First, so-called target date funds assume that everybody the same age has similar investment needs. In other words, one 62-year-old is the same as the next when, in reality, they usually have very different risk profiles and investment needs.
Second, target date funds are based on analysis of past data that make investing in them a lot like driving down the road backwards using your rearview mirrors. Chances are you'll do just fine… until you hit a few curves, at which point you're more likely to wind up in a ditch.
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Third, fund managers have a reverse incentive to boost risk that is not clearly explained to investors, and even then, it's reluctant. Bond rates have been so low for so long now, for example, that Fidelity's fund managers have been unable to meet target fund date returns requirements by sticking to "their numbers" – meaning the preset allocations to specific investments that are supposed to result in highly specific growth and income by the targeted retirement date. So, they've compensated by going after far riskier investments than they should.
As long as markets rise, this is a bet that works. But, when they don't… the "funds with high concentrations in stocks are a time bomb," according to Ron Surz, president of research firm Target Date Solutions, as reported by Reuters.
I agree – chasing performance never ends well.
About the Author
Keith Fitz-Gerald has been the Chief Investment Strategist for the Money Morning team since 2007. He's a seasoned market analyst with decades of experience, and a highly accurate track record. Keith regularly travels the world in search of investment opportunities others don't yet see or understand. In addition to heading The Money Map Report, Keith runs High Velocity Profits, which aims to get in, target gains, and get out clean. In his weekly Total Wealth, Keith has broken down his 30-plus years of success into three parts: Trends, Risk Assessment, and Tactics – meaning the exact techniques for making money. Sign up is free at totalwealthresearch.com.