June 18, 2009
Edelman Financial President Testifies at Joint Hearing on Target Date Funds
Transcript of Edelman Financial President Ed Moore's testimony
My name is Ed Moore, and I am president of Edelman Financial Services, based in Fairfax, Virginia. Our firm provides financial advice to thousands of individuals and families, and we currently manage more than $3.5 billion in assets. Unlike other firms that primarily serve high net worth investors, our firm caters to middle class consumers — our hands-on experience advising clients allows me to give you an in-the-trenches perspective on how target date funds are actually being used by ordinary consumers.
Our experience has taught us that target date funds pose specific dangers to investors. I would like to describe these problems and offer you two simple solutions that can protect America’s investors from these problems.
American workers are responsible for making their own investment decisions regarding their retirement plans at work, yet in a 2006 survey by John Hancock 69% of workers admitted that they lack investment knowledge, and 67% said their fear of market volatility prevented them from managing their 401(k) properly.
Target date funds seem to solve this problem. The theory is that a target date fund would allocate a person’s assets based on a projected retirement date: someone planning to retire in 20 years would choose a 2030 fund, while a person retiring sooner might choose a 2020, 2015 or 2010 fund. But in practice, this concept doesn’t work, because no two target date funds have the same asset allocation, investment holdings, turnover rate or glide path. The result is that investors are gambling that the one target date fund offered by their plan is right for them.
For example, Morningstar lists 153 mutual funds that offer a target date of 2010, with total assets as of January 31, 2009, of $22 billion. Yet, there is little consistency in the funds’ holdings, according to a review I conducted. According to Morningstar, 14 of the 2010 funds hold more than 60% of their assets in stocks, while 15 hold less than 30% — and one had less than 19% in stocks!
The 2008 returns for these funds was just as broad, according to Morningstar. Six of the 2010 funds lost more than 40% of their value last year, while four lost less than 10%. Yet people who invested in 2010 funds thought they were all the same: a recent survey by Envestnet Asset Management Inc. found that 38% of consumers expected the risk levels of funds with the same target date to be very similar.
A final problem is that many workers don’t know that target date funds are comprised of other funds. As a result, most of those who use target date funds use them incorrectly. If you use a target date fund, you’re supposed to place all of your assets into it, allowing the fund to provide you with the asset allocation and glide path you need. But a 2009 white paper by Janus Capital Group found that most of the people who own target date funds in their 401(k) plans own six funds, including both target date funds and other mutual funds. Nearly two-thirds incorrectly believed that target date funds need to be combined with other funds to create a diversified portfolio.
According to the Thrift Savings Board, which oversees the retirement plan used by employees of the federal government, 55% of plan participants who use the plan’s L funds also have money in other funds offered by the plan — and 16% have money in every fund offered. It’s even worse in private-sector plans. According to Vanguard, which offers its own version of L funds to 401(k) plans nationwide, 63% of plan participants use L funds in addition to other funds.
Target date funds are also often more expensive than other funds, increasing the fees that consumers are paying for their investments. The total cost of a typical L fund is twice as much as the typical mutual fund, according to Money Management Executive.
These problems occur for two reasons: first, each fund is permitted to create its own asset allocation, investment holdings and glide path without any constraint, regardless of its target date, and is permitted to change its asset allocation, holdings and glide path at will; and second, workers are being given access to these investments without the requisite education, information and disclosure they need in order to make informed investment decisions.
Edelman Financial Services LLC offers you two simple, easily implemented solutions to solve these problems.
First, prohibit the use of dates in the fund’s name. Allowing funds to refer to themselves solely by a year is highly misleading, especially since there are no industry standards regarding portfolio construction or management of these products.
Second, require these funds to disclose their asset allocation and glide paths, and require them to adhere to them. By showing investors how the funds are constructed and how they will evolve over time, investors will be able to determine if the funds are suitable. This methodology is commonly used by Section 529 College Savings Plans very effectively, and there is no reason this approach cannot be used here.
These two simple improvements will dramatically help investors make informed and effective investment decisions. Thank you for this opportunity to appear today.
<< Back
Edelman Financial President Testifies at Joint Hearing on Target Date Funds
Transcript of Edelman Financial President Ed Moore's testimony
My name is Ed Moore, and I am president of Edelman Financial Services, based in Fairfax, Virginia. Our firm provides financial advice to thousands of individuals and families, and we currently manage more than $3.5 billion in assets. Unlike other firms that primarily serve high net worth investors, our firm caters to middle class consumers — our hands-on experience advising clients allows me to give you an in-the-trenches perspective on how target date funds are actually being used by ordinary consumers.
Our experience has taught us that target date funds pose specific dangers to investors. I would like to describe these problems and offer you two simple solutions that can protect America’s investors from these problems.
American workers are responsible for making their own investment decisions regarding their retirement plans at work, yet in a 2006 survey by John Hancock 69% of workers admitted that they lack investment knowledge, and 67% said their fear of market volatility prevented them from managing their 401(k) properly.
Target date funds seem to solve this problem. The theory is that a target date fund would allocate a person’s assets based on a projected retirement date: someone planning to retire in 20 years would choose a 2030 fund, while a person retiring sooner might choose a 2020, 2015 or 2010 fund. But in practice, this concept doesn’t work, because no two target date funds have the same asset allocation, investment holdings, turnover rate or glide path. The result is that investors are gambling that the one target date fund offered by their plan is right for them.
For example, Morningstar lists 153 mutual funds that offer a target date of 2010, with total assets as of January 31, 2009, of $22 billion. Yet, there is little consistency in the funds’ holdings, according to a review I conducted. According to Morningstar, 14 of the 2010 funds hold more than 60% of their assets in stocks, while 15 hold less than 30% — and one had less than 19% in stocks!
The 2008 returns for these funds was just as broad, according to Morningstar. Six of the 2010 funds lost more than 40% of their value last year, while four lost less than 10%. Yet people who invested in 2010 funds thought they were all the same: a recent survey by Envestnet Asset Management Inc. found that 38% of consumers expected the risk levels of funds with the same target date to be very similar.
A final problem is that many workers don’t know that target date funds are comprised of other funds. As a result, most of those who use target date funds use them incorrectly. If you use a target date fund, you’re supposed to place all of your assets into it, allowing the fund to provide you with the asset allocation and glide path you need. But a 2009 white paper by Janus Capital Group found that most of the people who own target date funds in their 401(k) plans own six funds, including both target date funds and other mutual funds. Nearly two-thirds incorrectly believed that target date funds need to be combined with other funds to create a diversified portfolio.
According to the Thrift Savings Board, which oversees the retirement plan used by employees of the federal government, 55% of plan participants who use the plan’s L funds also have money in other funds offered by the plan — and 16% have money in every fund offered. It’s even worse in private-sector plans. According to Vanguard, which offers its own version of L funds to 401(k) plans nationwide, 63% of plan participants use L funds in addition to other funds.
Target date funds are also often more expensive than other funds, increasing the fees that consumers are paying for their investments. The total cost of a typical L fund is twice as much as the typical mutual fund, according to Money Management Executive.
These problems occur for two reasons: first, each fund is permitted to create its own asset allocation, investment holdings and glide path without any constraint, regardless of its target date, and is permitted to change its asset allocation, holdings and glide path at will; and second, workers are being given access to these investments without the requisite education, information and disclosure they need in order to make informed investment decisions.
Edelman Financial Services LLC offers you two simple, easily implemented solutions to solve these problems.
First, prohibit the use of dates in the fund’s name. Allowing funds to refer to themselves solely by a year is highly misleading, especially since there are no industry standards regarding portfolio construction or management of these products.
Second, require these funds to disclose their asset allocation and glide paths, and require them to adhere to them. By showing investors how the funds are constructed and how they will evolve over time, investors will be able to determine if the funds are suitable. This methodology is commonly used by Section 529 College Savings Plans very effectively, and there is no reason this approach cannot be used here.
These two simple improvements will dramatically help investors make informed and effective investment decisions. Thank you for this opportunity to appear today.
<< Back
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