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Target-Date Funds Are Having a Bad Year

When stocks and bonds fall, even supposedly all-weather retirement funds can wash out

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When 401(k) retirement plans were first rolled out, one thing was abundantly clear: Many investors simply didn’t have the knowledge or inclination to manage their money. Rather than a do-it-yourself investment program, investors wanted a do-it-for-me plan. 

The financial industry’s answer was target-date funds, which gear their investments toward a projected retirement date — say, 2030 or 2045. As the date approaches, these mutual funds pare back their riskier holdings, such as stocks, and start to load the portfolio with less risky investments, such as cash and bonds. Since their rollout in 1994, the funds have proven spectacularly popular, gathering millions of investors and nearly $3.3 trillion in assets by the end of 2021.

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The idea is to make the portfolio sturdier and less risky as retirement approaches, because retirees have less income to make up for their fund’s losses. And it has worked reasonably well — until this year. 

The 10 largest funds aimed at people who plan to retire in 2030 have lost an average 20.4 percent, about the same as the Standard and Poor’s 500 stock index, according to Morningstar, the Chicago investment trackers. Although this isn’t a reason to abandon target-date funds, it is a good reminder to look closely at how your fund manages your retirement money.

Tough markets

Normally, the prices of stocks and bonds move in opposite directions. Stocks are the wild-eyed optimists of the investment world, soaring when the economy booms, corporate profits rise and interest rates fall. Unfortunately, when they fall, they fall hard.

Not only have U.S. stocks suffered a 20 percent (or more) loss, overseas stocks got clobbered as well — so diversifying worldwide, normally seen as prudent, only added to a target-date fund’s woes. Stocks in countries that use the euro, for example, have tumbled nearly 23 percent this year, thanks to the war in Ukraine and the soaring dollar.

Bonds, on the other hand, are only happy when it rains. A bond, like a bank CD, pays a fixed rate of interest to its owner. When interest rates rise, investors spurn older bonds with lower interest rates, and the bond falls in value. Typically, a mix of stocks and bonds produces a less volatile ride over time, with smaller gains than stock funds, but smaller losses, too.

But “typically” doesn’t mean “always,” and rising interest rates in 2022 clawed stocks and bonds almost equally. As stock funds registered double-digit losses, bond funds did, too. Large funds that invest in a diversified array of bonds have fallen 15 percent this year, according to Morningstar. Some funds invested in higher-yielding long-term bonds, which also fall hardest when interest rates rise.

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Even Treasury Inflation-Protected Securities, or TIPS, have fared poorly. Although TIPS have inflation protection, they are still bonds, vulnerable to rising interest rates. Typical TIPS funds are down about 12 percent this year, according to Morningstar.

What to watch for

Different target-date funds take different approaches to investing, and you should know how those approaches affect investment returns.

To vs. through. In industry parlance, a target-date fund’s gradual shift from stocks to bonds is called its glide path. Some funds’ glide path takes them to a bond-heavy portfolio at the target retirement date, and the fund’s portfolio doesn’t change much after that.

Other funds, however, have a longer glide path, because at 65, you could still have 20 years or more of life in retirement — and in that time period, you need some stocks to keep returns high. These funds might not reach their most conservative point until many years after the target date. It’s likely that “through” funds with heavier stock holdings fared worse in 2022 than their “to” cousins. By and large, you should expect more volatility in a “through” fund than a “to” fund.

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Expenses. Mutual funds charge fees for their services, and those fees come from the fund’s assets. The more you pay in fees, typically, the less you get in performance over the long term. One way that target-date funds cut expenses is to invest in stock indexes, such as the Standard and Poor’s 500. Target-date funds that are actively managed charge an average of 0.8 percent in expenses, while those that use indexes charge an average of 0.32 percent, says Morningstar analyst Megan Pacholok.

Risk. Target-date funds aimed at retirement 20 years or more in the future will tend to have higher amounts of stock in their portfolios: After all, you have 20 years to make up for losses, and stocks tend to fare better over the long term than bonds or bank accounts. In years when the stock market is down, you should expect some losses.

What to do

What should you do if your target-date fund got clobbered this year? “It’s hard to hear, but I think what I would say is, ‘Stay the course,’ ” says Pacholok. 

That’s because the pain will abate eventually. The garden-variety bear market lasts about 11 months and gets back to pre-downturn levels in approximately 11 months, according to Sam Stovall, chief investment strategist at stock research firm CFRA.

Taking money out of a fund when it’s down simply magnifies your losses. If your fund is down 20 percent and you withdraw 5 percent, your account would be down 25 percent. “If you're closer to retirement or in retirement, maybe think about the way that you’re spending, so you’re not depleting that base,” Pacholok says.

Finally, bear in mind that a target-date fund is designed to be an all-in-one solution, and that adding additional funds to your holdings could make your overall portfolio riskier. Adding a new stock fund, for example, would simply tilt your savings further into a risky area. Moving to a money market fund would reduce your returns dramatically, making it unlikely that your savings would recover.