Pension Funds

Here’s what frustrates me about personal financial discourse: lads obsess over the flashy stuff while ignoring the issues that actually matter.

Take this post, for example. It highlights a problem that should have everyone paying attention. Why? Every working person is forced to participate in some form of pension or retirement plan. The math is simple: if the system is broken, you get hurt. If fees are too high, you get hurt. If investments underperform, you get hurt. This isn’t theoretical: it’s your retirement we’re talking about.

Yet here’s what actually happens: crickets.

The average person scrolls past pension reform discussions faster than they skip LinkedIn thought leadership posts. Even among the financially-interested crowd, people who should or want to know better, these critical structural issues get drowned out by whatever’s trending. Private equity drama? That gets clicks. Fee transparency in pension schemes? Yawn.

This is backwards thinking at its finest. We’re debating the colour of the curtains while the house burns down.

The solution isn’t complicated, but it requires something we’re not great at: sustained attention on boring, important things. Call your representatives. Vote based on what matters. Make pension management as exciting as arguing about stock picks on Twitter. Because here’s the reality: flashy investment stories make for good content, but structural reform makes for good retirements.

Well, I would not hold my breath on this. Even if I convince every person who understands the importance of pension funds to pay attention, they represent maybe 10% of the voting population. Maybe less.

Target Date Funds

This post is a “reaction” to a recent episode of the Rational Reminder, an interview with David C Brown on his research on Target Date Funds included in American retirement plans. While this specific conversation is targeted at what happens in the US, many lessons can also be generalised for this side of the pond.

The Promise vs. The Reality

Target Date Funds are supposed to be the “set it and forget it” solution for retirement investing. The idea is beautiful in its simplicity: pick the fund that matches when you want to retire, and it automatically adjusts from risky (lots of stocks) when you’re young to safe (lots of bonds) when you are in retirement. It’s like having a financial advisor, but automated and theoretically cheaper.

But here’s where things get spicy: the execution is often terrible, expensive, and designed (who would have guessed?) more to benefit the fund companies than you.

Let me paint you a picture. Imagine you’re forced to buy groceries from only one store (because that’s where your employer has an account), and that store charges you $7 for the same carton of milk you could get elsewhere for $1. Oh, and you can’t see the price until after you’ve bought it. That’s basically what’s happening with many workplace retirement plans.

The Fee Fiasco

David C. Brown’s research reveals something infuriating: many Target Date Funds are charging 70 basis points for the exact same underlying investments you could buy for 10-15 basis points elsewhere.

Over a 30-year career, we’re talking about tens of thousands of dollars in extra fees. For the same product. The system is designed to extract maximum fees while keeping you trapped. Your employer picks the plan provider, you’re stuck with their fund options, and there’s essentially zero competition once you’re in.

This is not unique to the US. One of my employers in the UK picked Royal London as our pension manager: they offered employees BlackRock ETFs at 4x the fees! The same ETF I could buy with IBKR, in the pension wrapper was costing multiples more (oh, yes, the name had something like “eagle” added, or some other bs…). Same shit in Italy and Switzerland: your pension option is uniquely determined by your employer.

This regulatory “choice” is even more silly these days. The idea to curtail employees’ freedom was that otherwise they would go and gamble their money on risky and opaque products. Imagine that when the asset management industry lobbied left and right to stick Private Equity&co into pension plans. At that point, just opened it up entirely then.

The Glide Path Problem

The glide path, how your allocation shifts from stocks to bonds over time, is where things get really interesting. Most Target Date Funds follow a simple rule: start with lots of stocks when you’re young, gradually shift to bonds as you age. It makes intuitive sense: it allows you to compound faster while you work and avoid the sequence of return risk later, when you are approaching the moment you will need the portfolio to fund your consumption.

Research actually suggests that the optimal glide path looks more like a “V” shape: start aggressive, get conservative around retirement age, then get aggressive again. Why? Because inflation is a silent killer, and bonds might not keep up with rising costs over a 30-year (and counting) retirement.

Guess how many major fund companies use this V-shaped approach? None.

Why not? Because it would, most likely, freak people out. Imagine trying to explain to a 65-year-old why their “safe” retirement fund is suddenly buying more stocks. Even if it’s mathematically better, it’s a PR nightmare waiting to happen. So fund companies stick with the simple downward slope, even though it might not be optimal.

The Incentive Problem

Here’s the thing that makes this whole situation so frustrating: everyone involved has the wrong incentives.

Fund companies want to maximize the fees they collect and keep your money in their funds as long as possible. A V-shaped glide path might be better for you, but it’s riskier for them if spooked retirees start pulling their money out.

Employers want to offer retirement benefits without having to think too hard about them. They’re not investment experts, and they’re not getting paid to optimize your returns. They just want something that looks reasonable and won’t get them sued.

You want good returns at low cost, but you’re not given the tools or information to evaluate your options properly. The regulation that governs these plans is excessively loose compared to the rules for Defined Benefit pension plans (maybe this is a story for another day, you should see what type of triple jumps you, as the sponsor, have to do to satisfy DB pension Trustees).

It’s like everyone’s playing a different game, and the employee is the one paying for it.

The Allocation Absurdity

Here’s another thing that should make you question everything: why do these funds use 30 different equity funds instead of just buying one broad market index? Incentives, again.

If you’re a regular person trying to save for retirement, do you really care whether your fund “tilts toward value stocks” or has a “small-cap growth allocation”? Probably not. You just want your money to grow reasonably well. Again, that’s the person the regulator had in mind when they designed the rules.

But fund companies love complexity because it justifies higher fees (on the premise that they aim to deliver higher risk-adjusted returns). They can say “look at all this sophisticated portfolio management we’re doing for you!” while charging you extra for the privilege of owning a complicated version of what could be a simple, cheap index fund. And keep you in their box, in case you would peek under the curtain and be reassured your money is indeed chasing the latest financial fad.

The funny aspect of this point is that in Europe we do not even get that. For better or worse, we get higher fees…just because.

The Competition That Doesn’t Exist

In most markets, competition drives down prices and improves quality. This is especially true in personal finance: look what ETFs did to the Mutual Fund industry or what index funds did to active management.

But retirement plans create weird monopolies. If your employer uses Vanguard, you can only pick Vanguard funds. If they use Fidelity, you’re stuck with Fidelity options.

There’s no mechanism for you to say, “hey, I’d like the cheaper option from that other company, please.” You get what your HR department picked, and that’s it. And these, the US and the UK, are the LUCKY places: you can still push your HR to change for the better. In Italy and Switzerland, you are really stuck with what you’ve got.

Once you accept that a glide path approach makes sense (which it does), you run into what I call the “benchmark problem.” How do you fairly judge a fund that’s designed to change its allocation over time?The best-designed glide path can look mediocre in hindsight simply because we only live through one possible future, not all the scenarios the designers planned for.

The average employee has no way to evaluate whether their fund manager made smart decisions about the path itself. Heck, most HR departments can’t do this analysis properly either.

The Stock Allocation Shortcut

Here’s where things get weird: most fund managers take a shortcut by linking glide path “risk” directly to stock allocation. But this is fundamentally flawed thinking, especially when you consider that bonds can actually be riskier than stocks over the 30-40 year periods these funds are designed for.

Think about the 2020-2022 period, where bond holdings got hammered while stocks recovered relatively quickly. According to conventional wisdom, those bonds were supposed to be the “safe” part of the allocation.

What David Gets Right

David’s research makes a lot of sense because it focuses on what we can actually measure objectively: fees and active management costs within each asset class. This cuts through the noise of glide path philosophy and gets to the nuts and bolts of fund construction.

Unfortunately, even armed with this data, the average employee is still left wondering whether they should push their company to switch fund providers. They see the final, all-in results (which include the glide path decisions) and can’t separate good management from good luck.

The HR Department Dilemma

This creates what I call the “financial advisor problem” for HR departments. Even when they do their homework and choose the best fund, they face a no-win situation. If stocks underperform for a few years, employees might see their fund “losing” and wonder why HR isn’t doing anything about it.

It’s like being a financial advisor during a market downturn. If you do nothing (which is often the right move), clients think you’re not earning your fee. If you make changes just to show activity, you might actually hurt their long-term returns. Either way, you risk getting fired.

The Rational Reminder Insight

What fascinated me about the Rational Reminder podcast discussion was this assumption that asset managers are genuinely researching the “best” glide path. In reality, I think they’re just optimizing for the strategy that keeps money (and fees) with them the longest. That makes perfect business sense. If you’re running a company that manages other people’s money, your primary job is to stay in business.

Look at what happened with Moneyfarm in Italy. They got criticized for actively managing their supposedly “static” asset allocations. Finance-savvy clients were furious when their 80/20 portfolio got tweaked too frequently. But put yourself in Moneyfarm’s shoes. They don’t know how financially literate their clients are. They’re probably thinking: “Will this person stick with an 80% stock allocation after the market dropped 20%?”. Academic righteousness doesn’t pay the bills. Keeping clients invested does. They had to bet on what type of client they had, and I think they made the right one (business-wise): if you want an 80/20 and know the importance of sticking to your asset allocation, you are not paying Moneyfarm relatively high fees but DIY.

The Wisdom of Crowds Problem

I’m not completely sold on taking “the index fund idea to an asset allocation level.”, meaning use as a glide path benchmark the weighted average path employed by different asset managers.

As I said earlier, we have pretty convincing research showing that V-shaped glide paths outperform the traditional downward-sloping ones and yet no asset managers use them.

There’s no real “wisdom of crowds” in target date funds because nobody has the right incentives to do the optimal thing.

The whole glide path concept isn’t even THE solution. During accumulation, a 100% stock portfolio does not maximize expected wealth (I do not think I’ll ever see those schemes use leverage to diversify…or go beyond stocks and bonds for that matter).

(this is a Golden Butterfly levered 1.5x from 1973 – cost of leverage RFR+0.4%)

For retirement, various stock/bond combinations don’t maximize safe withdrawal rates. Glide paths are designed as “good enough” solutions for people who don’t want to think about finance, a “less irrational crowd” at best.

A Sensible Framework

Target date funds are a good idea poorly executed, at least from a pension-regulation POV. Too much regulation kills innovation, but David’s research shows that many current implementations are worse than basic static allocations.

Here’s what a sensible regulatory framework might look like:

Use only index funds – No active management layers adding fees without adding value.

Keep it simple – Use a handful of broad market funds, not 20 different asset classes.

Set it and forget it – Establish the glide path at inception and stick to it.

But common sense rarely works in finance. Set these rules too strictly, and you prevent legitimate adjustments in edge cases. Make the definitions too loose (what exactly is an “index fund”?), and the regulation becomes meaningless.

The Real Solution

The dispersion in target date fund returns isn’t necessarily bad: it encourages research and competition. But we need transparency.

The ideal world? Government-published KPIs for each fund that let employees make informed decisions AND the freedom to switch providers easily. Give people the data they need and the power to act on it.

Because at the end of the day, target date funds should serve the people saving for retirement, not the companies collecting the fees. Getting those incentives aligned is the real challenge we need to solve (anywhere in the world).

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