You must unlearn what you have learned.
When mutual fund companies start quoting Yoda while trying to persuade you to hand over your money, it's a sure sign that something new is going on.
But Pimco, a bond specialist now selling the popular target-date retirement funds that blend stocks and bonds and become more conservative as you near retirement, would have you believe that it has a revolutionary approach to these funds, which populate most employers' 401(k) and other plans.
Pimco believes we are experiencing a "new normal," where markets in the future are much less likely to deliver the returns people remember from retirement investing in the 1980s and 1990s.
Plenty of people have ended up looking like idiots after declaring that this time is different, so it's tempting to dismiss their proclamations as a lot of hot air. But Pimco has created its RealRetirement target-date funds with a strategy that appears to be custom built for these skittish times. There's less money in stocks, more inflation protection, hedging to protect against large losses and freedom for the Pimco fund managers to make bets on the fly.
For the period that began March 31, 2008, and ended in the middle of this month, Pimco's funds for people retiring in 2020 and 2040 outperformed each of the big three in the target-date arena — Fidelity, T. Rowe Price and Vanguard — according to Morningstar data.
Still, the margin of victory was less than one-quarter of a percentage point annually in both cases. That outperformance is something, though.
Target-date funds grew out of the utter lack of preparedness that many people felt when employers decided to abandon pensions and make workers pick investments in a 401(k).
So a 25-year-old today can invest in a 2050 fund with a high allocation of riskier assets like stocks. Over time, the fund would gradually switch to bonds and other more conservative investments that can reduce risk as retirement looms.
Pimco introduced some of its target-date funds right before the stock market fell to pieces in 2008, taking many 2010 and 2015 target-date funds that had a lot of money in stocks down with it. What Pimco had surmised was that one big loss near retirement would set many retirees back so far they'd have difficulty recovering. So it wanted to try to protect people from that.
"You only get one shot to do this properly," said Vineer Bhansali, the Pimco managing director who oversees the investment strategy behind the target-date funds.
One way Pimco tries to avoid hyperinflation is by gradually moving as much as 35 percent of the target-date portfolio to TIPS, which are U.S. Treasury bonds with built-in inflation protection. To avoid outsized stock market risk, Pimco's targets for its stock allocation are never higher than 55 percent.
Another big difference here are the hedges that Pimco has in place to protect against a collapse in the stock market. By using various complex tools, Pimco sets a maximum loss it is willing to tolerate. For a fund with a retirement date that is relatively soon, it wants no more than a 5 percent loss; for a retirement date that is much further away, it may be willing to suffer a 15 or 20 percent decline, although the targets can move some.
Opening the funds in early 2008 was the ultimate test for the strategy, given the enormous losses in the stock market over the next year.
"We were very nervous about whether it was going to work, but we never busted the boundaries," Bhansali said.
Hedging is not free, and its costs, which can range from roughly half of a percentage point to 1.25 percent annually, act as a drag on returns. Bhansali, however, argues that if the hedges work, he can sell options, say, that are more valuable when markets are in free fall and then use the proceeds to buy newly cheap investments.
They had better, because as John Ameriks, who heads investment counseling and research for Vanguard notes, those hedging costs add up. "The math is not perfect, but you basically multiply the annual extra costs by the number of years, so at 1 percent annually you're losing 30 percent of your gains over 30 years," he said.
"Theirs is a very skeptical view of what equities will generate," Ameriks said. "I suppose one is entitled to take that view. But it's not consistent with longer-term history."
So let's say you bet your retirement on this unproven model, which anyone can do, given that the Pimco funds are available through brokerage firms. And let's say you ignore the fact that few big employers have chosen so far to adopt the funds for their retirement plans, due to their lack of a long track record. And assume that these Pimco funds underperform competing funds by a percentage point or two each year over 30 years. What then?
Well, Pimco has its own downside covered here. Its research offers a sober piece of advice that just may solve all investors' problems, no matter whose fund family they adopt. Pimco, perhaps self-servingly, declares that people may need to save 20 percent of their pay to reach a goal of replacing just 40 to 60 percent of their income in retirement.