Why Target Date Mutual Funds & Couch Potato Strategies May No Longer Work

target-datecouch

The major bull market in bonds has lasted for nearly 33 years. The 30-year Treasury yield hit its all-time a high of 15.20% on Sept. 29, 1981 and the 10-year’s yield record high came the next day, at 15.84%. In contrast, today, the 30-year yield is 2.84% and the 10-year’s is 2.24%.

US Treasury Bond  Rates At 114-Year Low                                                          

The astounding chart below shows that the Fed has successfully forced T-Bond Interest Rates to lowest level since 1900. Only once in all this time did rates reach the 2% level and that was in 1940!

 

bond1

 

In my humble opinion, the bull market in bonds is over. Fed chair, Janet Yellen wants to raise rates sometime in 2015 which will decrease the value of bonds and increase the yields. Q.E. in Japan and Europe have already caused negative yields on foreign bonds. A bear market in bonds will make target date mutual funds and couch potato strategies less effect in reaching retirement goals.

 

INVESTOPEDIA EXPLAINS ‘Target-Date Fund’

A younger worker hoping to retire in 2050 would choose a target-date 2050 fund, while an older worker hoping to retire in 2025 would choose a target-date 2025 fund. Because it has a longer time horizon, the 2050 fund would likely be weighted heavily toward stocks, with a relatively small percentage of bonds and cash equivalents, while the 2025 fund would hold relatively more bonds and cash equivalents and fewer stocks so it would be less volatile and more likely to contain the assets the investor needs to begin making withdrawals in 2025.

The fund’s managers then rebalance the fund’s assets each year and keep its investments on track to meet the fund holders’ goal of using that investment to begin paying for their retirement in a particular year.

What is the Couch Potato strategy? 

The Couch Potato strategy is a do it yourself technique for building a diversified, low-maintenance portfolio designed to deliver the returns of the overall stock and bond markets with minimal cost. The strategy, also called index investing or passive investing, has been around for decades. It has become far more popular in recent years, as new products and online discount brokerages have made it easier to implement. Anyone can now build and maintain their own portfolio using index mutual funds and exchange traded funds (ETFs).

Both strategies have become very popular in recent years because research shows that actively managed funds underperform the overall market.

Standard & Poor’s reports that over the five years ending in 2013, about 22% of actively managed Canadian equity mutual funds delivered higher returns than their benchmark index, while the figure for US equity funds was about 12% and for international equities was just under 14%.

The major problem of both these strategies is increasing your bond exposure as you get older. With interest rates near all-time lows, return on bond funds over the next 10 years will be well below historical averages. The SPDR Barclays Long Term Treasury ETF yield to maturity is 2.62% Even if we assume that rates remain at historically low levels over the next 10 years and that average yields are still 2.6% in March 2025, your total return in bonds will be only 2.6% per year. This of course is a best-case scenario. If interest rates rise at all, the returns on bond funds will be even lower and unlikely to keep pace with inflation especially after paying income tax on withdrawals.

Investors in their late forties and early fifties saving for retirement are in for a big surprise if they increase their exposure to holding more bonds as they get older. The next 30 years are going to be a lot different than the last 30 years in the bond market returns.

With all this money printing  world wide, could we revisit the hyper inflation crisis of the 1980’s?  I will never forget my bank offering me a 5 year fixed term mortgage at 21% when it came up for renewal in 1982! Lucky for me that I was smart enough to renew for only one year at 17.5% and interest rates came tumbling back down.

Disclaimer: This post is for discussion purposes only!!

 

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3 thoughts on “Why Target Date Mutual Funds & Couch Potato Strategies May No Longer Work

  1. great article! Being retired now for 4 ½ years, I still do not invest much in bonds. I do not like the target-date-fund very much. Since I only need the minimum required amount from my 401K, the remainder is invested in stocks and alternative investments.

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  2. Between politically set interest and inflation rates, normal investment strategies seem foreclosed. The substitutes in use seem beyond the capabilities of most financially untrained people and risky for those with knowledge. And the government safety net substitutes are insolvent. Commodities, including precious metals, are heavily politicized as well. I find it more than challenging to define a reasonably strategy for long term security these days. Learning that the IRS is quietly delaying payment of 2014 tax refunds in many cases is downright scary!

    Liked by 1 person

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