Small Caps and Brazil

A coupe of interesting things I've noticed in the market. First, large cap stocks have made new rally highs, besting their highs from October. Small cap stocks have not. This is considered to be a negative divergence and not generally a positive sign. You can see in a chart comparing the DIA and SPY (the ETF of the Dow Jones Industrial Average and S&P 500 respectively which are considered large cap) to the VB (the Vanguard Small Cap ETF) that VB has not been able to top its high from mid October while DIA and SPY have both reached newer highs.

SPDRs (SPY)">

Second thing to note, The Economist magazine recently put Brazil on the cover with the title "Brazil Takes Off." When a stock, sector, country, etc. makes the cover of a major magazine like The Economist or Business Week, that generally is more indicative of a market top to that investment theme than the beginnings of one. There have been statistical studies that have shown this to be true. Brazil still looks strong at this point but keep a closer eye Brazil related holdings in case it should falter.

Issues with Target Date Funds

So last week in my post on the 401k I said the concept of the Target Date fund was a good idea but that I had issues with how some were being implemented. The Senate recently held hearings on Target Date funds and the report is available here. The good stuff begins on page 8.

They address the fees associated with some of the target date funds. The fees are based on two things: the fees of the underlying funds and the overlay management fee. Target date funds are a combination of funds run by a specific fund company and then reallocated based on time as you get closer to the target date. So, a Vanguard Target Date fund holds X number of Vanguard funds in a certain allocation mix. Those individual funds all have fees associated with them. Vanguard will then charge between .10 and .25% to run the allocation mix. If your company has picked an insurance company family of funds you are going to pay a lot more in fees because their funds normally have higher fees, not to mention underperformance. If you have Vanguard funds, you will pay a lot less. Page 15 and 16 of the report list the bigger fund families and their fees; you may want to see where your Target Date funds stand.

Paying higher fees for a Target Date fund than a regular fund is just a cost of doing business. There is good amount of commitment needed to manage your 401k well. If you don't feel you are able or simply don't want to make that commitment then you are paying someone else to do just that when you choose a Target Date fund.

The other issue they address is the difference between how Target Date funds allocate the assets; which means how much risk they are taking. I find this much more concerning. They found that 2010 target date funds, which would be a person anticipating retirement in 2010, had equity allocations between 24% and 68%. I can possibly see 24% but any reasonable person one year from retirement should not be 68% invested in equities. Why the difference? Well for one, there are no standards governing what allocation target date funds should have. Then, different fund families have different ideas about what the goal of a target date fund should have. Some may just be greedy because they can charge more for higher equity portions.

When you reach retirement you want to have either enough in fixed income to generate enough income to live off of or enough to buy an immediate annuity to provide that income. Anything left over at that point you can consider holding some equity positions. For most people that will be a relatively small percentage; along the lines of 20% or so. It should be nowhere near 68% like some of these target date funds have.

The moral of the story, make sure you know what you are buying and make sure it fits your investment needs.