Nobel laureate and M.I.T. professor of economics Robert Merton doesn’t think much of target-date funds.
Excerpts from the November 2, 2015 online edition of Advisor Perspectives:
Target-date funds are an exceptionally bad way to save for retirement, according to Robert Merton.
Merton is a professor of economics at M.I.T. and was awarded the Nobel Prize in economics in 1997 for his contributions to the Black-Scholes option-pricing model.
Merton spoke about target-date funds during his keynote speech on October 26 at the national conference for the members of Buckingham Asset Management (BAM) alliance, held in St. Louis.
The idea that the design of target-date funds is based solely on one’s age doesn’t pass a “minimal test of common sense,” he said.
Let’s look at Merton’s analysis.
The peril of target-date funds
For every retirement product, Merton said, the measurement of success should be income. Income is how one determines their desired standard of living. You don’t need a principal sum to live, he said. You need a certain level of inflation-adjusted income.
Everywhere, except in the defined-contribution (DC) world, retirement success is measured in income, he said. For example, pension plans measure success by their “funded status,” which in effect is the degree to which the plan can meet its participant’s projected income payments. But in the DC world, which includes target-date funds, success is measured as a principal target.
“You have to set a goal and measure the progress toward it the right way,” said Merton.
Target-date funds have a date, which Merton said “makes you feel good.” He reminded the audience, though, that the 2010-target funds still exist, which should cause one to question the meaningfulness of a fund’s target date.
More to the point, Merton said there are no goals in the prospectus of target-date funds; there is a process, which is the glide path. The date, he said, is the date that the process stops.
Technology has advanced, Merton said, and much more is possible in terms of providing customized advice and products. The downside is that complexity has increased, and so has the need for competent advice, according to Merton.
Target-date funds get more conservative by increasing exposure to fixed-income. But, Merton said, it matters what type of bonds they hold. If they put you in three-five year nominal bonds, for example, they don’t protect you against inflation.
Your chance of getting to a goal with a customized solution is much greater than with a generic solution.
His most strident criticism was that target-date funds lack customization and are based solely on one’s age (or, equivalently, the time to retirement).
“Imagine you got your medical advice by age, without respect to gender.” He asked rhetorically, “Would you settle for that for your prescriptions?”
“Why would think that it would be remotely possible that a single statistic – age – would be good enough to get you to a decent retirement?” Merton asked.
“To me that doesn’t pass the minimal test of common sense.”
That’s a good thing for advisors and the finance industry, he said. “If the answer using age was good enough, then this whole industry would have far too many resources devoted to it.”
“I’m not trashing target-date funds,” he said. “But why would you ever believe that age was good enough?”
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