Imagine that a doctor prescribes the perfect medicine to a group of patients. But almost none of those patients are going to take the medicine as prescribed.
Another medicine that’s 80% as effective but that every patient is willing to take may lead to a better overall outcome for the highest number of people.
It's through that lens that Clark recommends target date funds as the easiest, most one-size-fits-all solution for retirement investing. He calls it "the easy button" for retirement. It's a workable solution for almost everyone. It also requires minimal complexity, minimal risk and minimal knowledge.
Clark also focuses on another part of behavioral economics: giving people tools to spend less and save more while explaining how important it is to their long-term financial health.
Developing the right habits, and consistently saving and investing for decades during your working career, is the true key to preparing yourself for a successful retirement from a financial standpoint.
However, target date funds are not some magic bullet that automatically crushes every other possible retirement strategy. And from a pure performance standpoint, target date funds haven’t been at the very top of the list in terms of funds.
Is that because of a significant allocation toward international equities?
Is Clark Concerned That International Stocks Have Underperformed — And That Target Date Funds Invest Heavily Into Them?
What does Clark think about international equities underperforming in the last decade-plus compared to U.S. stocks? And does it give him pause when it comes to target date funds?
Asked Larry in Maryland: "I know you advise listeners that target date funds are great for long-term investing. In researching these, it seems each has a significant investment in foreign stocks that have underperformed U.S. stocks for long periods of time. Are you concerned about this?"
Clark himself allocates a large portion of his investment portfolio to international assets. He takes a decades-long view on investing and doesn’t fret about short-term or even intermediate-term results as long as he’s satisfied with his strategy. And to an extent, his allocation into international investments is about risk management.
That doesn’t mean he’s in love with that relative underperformance.
“I don’t like it because I have, gosh, I think right around 40% — foreign funds that haven’t performed as well as domestics, so maybe I’m one-third foreign in my equity holdings,” Clark says.
“If you know price-earnings ratios (P/E ratios), the markup essentially you pay to own U.S. funds is much higher than it is for foreign funds. And a lot of foreign economies are growing significantly faster than we are.
“As an American, obviously I invest in my home country. But for long-term financial security, long-term growth of assets and diversification of risk, I do invest significantly overseas.
“If you look back over the last decade that has been a fool’s errand and has not earned me the return that domestic would earn. But I’m playing a long game.”
The more widely you diversify your investment portfolio, the lower your long-term risk profile becomes. Some of that diversification allows for you to keep more of your money into equities than you otherwise would to achieve the same risk profile.
“So am I happy about it? No,” Clark says. “Have I changed it? No. Which means I’m either stubborn or I’m right on that.”
Morningstar Dives Deeper: Why Target Date Funds Have Underperformed
Morningstar recently evaluated the performance of target date funds, particularly in the last 15 years.
Vanguard and Fidelity are the two biggest players in the target date fund category. And their target date funds have consistently underperformed what Morningstar refers to as balanced funds from the two discount brokers.
Target date funds reallocate your portfolio based on your proximity to retirement. For example, as you near or enter retirement, target date funds lower your risk by shifting into bonds and away from equities.
Do balanced funds perform better because they allocate a larger percentage of their holdings to equities? It’s a common theory. But it fails to explain the difference in performance in the last five, 10 and 15 years, Morningstar found.
“Presumably, the balanced funds owned more equities,” Morningstar wrote. “Such is the usual explanation for performance differences among allocation funds — but not in this case.”
As Clark listener Larry astutely pointed out, the thorn in the (performance) side for target date funds has been foreign stocks.
"As it turns out," Morningstar explained, "balanced funds triumphed not because of their overall equity exposure, or the timing of their equity allocations, but instead because of their investments in foreign stocks — more specifically, their lack of foreign stocks."
Vanguard and Fidelity’s target date funds allocate about one-third of their portfolios to international stocks, Morningstar found. This is partially due to legal requirements tied to institutional investing that apply to 401(k) plans.
Final Thoughts
Target date funds are perhaps Clark’s favorite one-size-fits-all retirement investment recommendation. They’re simple and they’ll get you where you need to go.
They haven’t performed as well as some other funds in the last 15 years due to a heavier allocation toward international equities.
However, Clark thinks there’s reason to believe that foreign stocks may represent better value at the moment than U.S. stocks in many cases.
Taking a long-term, diversified approach to investing no matter what you choose is a tried-and-true method in which Clark believes.
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