Target Fund-Junk Bond Controversy is Overblown

Last week Bloomberg reported that six of the nine largest target-date retirement funds hold junk bonds in their 2010 portfolios. That in turn got the attention of Senator Herb Kohl who chairs the Senate Special Committee on Aging that has been taking a look at target date funds in the wake of steeper-than-some-expected 2008 losses. Senator Kohl's take on the junk bond news:

"The discovery that many 2010 target date funds contain junk bonds is troubling, but not surprising." In the Bloomberg article Kohl added: "Stronger regulation is needed to ensure that participants on the brink of retirement are not exposed to such excessive risk."
Retirement is not an Investing End Date That's just wrong. The date you retire is not an end date; it is a beginning date. At a minimum you need to plan on living in retirement for least 25 years and most financial advisors will tell you 30 years is even smarter. (Don't think you'll live that long? Think again.) So with that long-term perspective, it's wrong to make a blanket statement that junk is bad. Yes, of course, too much junk is a bad thing, just as too much of any asset class is a bad thing. But that's not necessarily what's going on. The Bloomberg article cited John Hancock Life Cycle 2010 fund as having 30 percent of its fixed income allocation in junk; but that represents just 12 percent or so of the fund's overall assets. For someone with a 30-year investment horizon where inflation is a huge threat, that doesn't strike me as irresponsible. (For a smart and nuanced take on junk, be sure to read Allan Roth's recent post on the matter.).

I'm all for Congress taking a look at ways to improve the 401(k). And it is of course true that too much junk would be a problem in any portfolio. But to insist that any amount of junk is dangerous seems off point. When John Ameriks of Vanguard was asked why the firm does not own junk in its target date funds he didn't cite their risk. Ameriks told PlanSponsor it was because Vanguard thinks junk bonds are too expensive. Now there's a worthy risk for Congress to set its sights on: 401(k) costs.

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