source -

As the US and global stock markets continue to show volatility, even as central banks around the world (Ms. Yellen as the exception) are racing to prop up their economies with negative yields, 401K investors should be monitoring their accounts closely and trimming funds that have declined more than 10%. For more than 20 years in the financial services industry, we have provided our 401k corporate clients model allocations for their employees to consider that are Conservative, Moderate, and Growth style portfolios adjusted for market conditions. Understandably, baby boomers nearing retirement are getting nervous as they watch the impact of recent stock market declines on their accounts. We have received multiple calls and emails asking for help from participants having already experienced 15% – 20% account declines just this year. In light of slowing global economies and growing risks, many are now just recovering from 30% to 50% account declines during 2008 financial crisis.

source -
source –

The question is what funds should you consider in your 401k plan to reduce risk? The only fund that has guarantees of principal protection will be the cash equivalent fund, typically money market or stable value funds. All other funds will have risks associated and potential to fluctuate in value. Many participants have chosen to use Target Date Funds that are diversified funds consisting of stocks, bonds, and cash with risk strategies based on years until retirement (defined as date you turn 65). With new provisions from the DOL, Target Date Funds as well as Risk Based funds are now acceptable as the default investment for retirement plans. Meaning, if you don’t select any investment type, you most likely will be automatically investing in the Target Date Fund or Risk Based fund that aligns with your retirement, based on your birth year. This is a result of behavioral economics making its way into the mainstream, something that we wrote about yesterday in our article titled Cars, Misbehaving, and the Highway to Wealth.


As illustrated above, the target date portfolio has high allocation to equities for younger participants and lower allocations for those nearing retirement. However, Target Date funds are not adjusted for market conditions so longer dated funds (e.g. Target Date 2040 for those retiring in year 2040) will fluctuate closer to stock indices than shorted dated funds (e.g. Target Date 2015 fund). Understanding how the target date funds are represented, one would assume that the shortest dated target fund would be mostly insulated from stock market risks. Unfortunately, this is not true.

Referring to the 2008 financial crisis, many soon to retire baby boomers began allocating to shorter dated target date funds in late 2007 and 2008 due to concerns about stock market risks. Their assessment was accurate, but their strategy proved disastrous losing 20% to 30% of the account value in 2008.

So what happened? They had been told that shorter term target date funds are adjusted more conservatively every year, and the shortest dated target date funds have the most conservative allocation of the group. What is not explained is “how conservative” and “conservative based to what.”

We researched on our Morningstar database all 2000 and 2010 target date A share funds in existence in 2008. Of these funds their performance in 2008 ranged from -11% to -30% (1). In reading through prospectus and marketing materials of target funds, we consistently find the lack of disclosure of the investment policy and how much equity allocation remains in the conservative target date funds which is positive in bull markets but a liability in bear markets. Target date funds are similarly designed based on the following two key components:

  • Target date funds incorporate “Modern Portfolio Theory” (MPT) that encourages a widely diversified portfolio over many asset classes of stocks and bonds.

  • Many conservative target date funds are allocated per MPT based on a long-term.

The 2000 – 2010 target date funds averaged 36% in equities that include allocations to technology, energy, and international stocks. The rationale for these shorter date target funds for significant equity allocations is that retiring participants will be slowly depleting their account over their life and not liquidating right at age 65. Therefore, when you see “Target Date 2010” you would assume it is designed for a short-term horizon with high cash allocations (since one had retired in 2010). Meanwhile, the designers of the fund still see it as a 20-year horizon and therefore, using MPT, have more equity exposure than one would expect.


During positive market environments, target date funds will benefit with the larger equity allocation. However, one must recognize that the more allocation to equities the more the fund will correlate with the stock market and even the shortest target date fund may not be as insulated from market risk as you think. Look at the portfolio allocation of your target date funds to determine how much is allocated to stocks versus bonds and cash. If you find these funds have higher percentages of stocks than you would like, reduce your risks by complimenting your target date fund with cash equivalent fund and/or investment grade corporate or government bond funds.

If you have any questions about your 401k or other retirement accounts, please drop a comment in the section below!