Target-Date Funds Are Having a Bad Year

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.

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.

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.