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Off Target: How a Popular Retirement Strategy Is Coming Up Short

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I’ll turn 50 this year, and I’m being honored with catch-up contributions and a colonoscopy. Although technically, a task force of doctors just lowered the recommended age for that test to 45, leaving new half-centenarians in diagnostic arrears, as it were.

The catch-up contributions are more straightforward. Workers turning 50 this year can add an extra $6,500 to their 401(k) accounts, on top of the standard $20,500. There’s a bill in Congress called Secure Act 2.0 that would boost catch-up contributions to $10,000 for 60-year-olds. It might even pass.

A 401(k) is an example of a defined-contribution fund, which is a polite way of saying that we know what goes into it, but it’s anyone’s guess what’s there by retirement age, or how long it lasts. These plans now make up 70% of U.S. retirement assets, double their 1980 share. So savers have to get their investment choices right, be willing to work longer, or keep an open mind between, say, Palm Beach and Papua New Guinea. (I’ve heard all good things.)

The money-management industry is here to help. Target-date funds, sometimes called life-cycle funds, first appeared in 1994, around when I got my first 401(k)-type job. If you remember Ron Popeil’s rotisserie roaster infomercials, you know enough about how these funds work. “Set it and forget it,” as the audience and Popeil used to say in unison. You pick one fund with your tentative retirement year in the name—maybe the Target 2040 fund, in my case. That’s it. An investment committee puts the money in the best mix of assets for your age, and changes percentages as you grow older.

I’ve never bought one, because I’m cheap, and target-date funds come with higher expenses than plain index funds. Maybe that’s for the best. A new report from BofA Securities calculates the performance for 2040 funds since 1994 and finds that they have trailed the S&P 500 by 2.4 percentage points a year.

On its own, that’s understandable. A stock and bond mix should provide lower returns than a stock index, but with less risk. But the report finds that the risk profile for the two has been nearly the same. A simple 60/40 mix of stocks and bonds would have provided higher returns than the target-date fund, with much lower volatility.

There are three main reasons target-date funds have struggled, says Jared Woodard, who heads the research investment committee at BofA . They allocate too much money to ex-U.S. markets, especially Europe and Japan. Investors would be better off picking a few stocks in those markets than buying indexes, Woodard says. The funds also assume that Treasuries and high-quality corporate bonds will always be a good hedge against stock downturns. When rates are rising, like now, investors might be better off with some of that money in cash, despite the inflation hit, and in instruments with higher credit risk but less interest rate risk, like junk bonds, senior floating loans, and emerging markets bonds.

The third reason is that target-date funds stick rigidly to their allocations and rebalancing rules, which is good for novice investors who would otherwise sit in all cash, but maybe not for experienced investors. “I’m not suggesting that people try to time the market,” says Woodard. “But I think in the case of some of these different investment vehicles, there’s just a bit of missed opportunity.”

Part of Woodard’s target-date critique applies to investing more broadly, and thus to those of us who don’t own those funds. The problem is, I can’t tell whether he’s right, or we’ve just reached a moment when ex-U.S. shares are exceptionally cheap, and beaten-down Treasuries have non-negligible yields for the first time in recent memory. I plan to feel less guilty about my home-country stock bias, at least. The only thing I’m confident about is the size of my 401(k) contribution this year. I plan to define the heck out of it.

Have you noticed that a $20 billion company called Waters (ticker: WAT) has gone from lagging behind the stock market to beating it since a new CEO named Udit Batra took over in September 2020? Maybe you haven’t. Waters sells scientific equipment, such as ion mobility mass spectrometers. I don’t know what they do, beyond ending friendly investing conversations. But the stock has returned 57% under Batra’s watch, more than double the S&P 500. It jumped 8% in a day after the company’s latest quarterly report.

Waters sells mainly to the drug industry and industrial customers, including for food, materials, and environmental testing. It has lately had 30% operating margins, 40% returns on invested capital, and high single-digit revenue growth, all above peer averages. I asked Batra what changes he has made at Waters. One is to introduce new products faster. He described a machine that has helped mRNA vaccine companies speed up their tests. Another hot area: testing materials for electric-vehicle batteries.

He’s also got the company focusing more on e-commerce, which is important for sales of consumables. Batra has boosted e-commerce to 30% of sales from 20%, and he says 70% is possible. Another focus is supplies, especially semiconductors. Batra has spoken directly with chip CEOs to learn which designs they can supply right away, and then worked those designs into his machines. At a recent investor day presentation, the company outlined plans for faster growth in the years ahead. We’ll see.

If you’re wondering how one comes to run a spectrometer company, by the way, Batra shared a transformative childhood moment involving an actual transformer. His Atari machine in India needed pricey D cell batteries. “The damn thing would go down,” he says. “You couldn’t play more than two games of Pac-Man.” His eighth-grade electronics teacher agreed to show him how to make a transformer to plug the machine in, if Batra would then teach the class. And one thing led to another.

The lesson is clear: My mother held back my success by including the plug with my Atari. Does anyone know a good therapist?

Write to Jack Hough at Follow him on Twitter and subscribe to his Barron’s Streetwise podcast.