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Hugely Popular Retirement Investments Flop in Bear Market

Target-date funds, a big hit in 401(k) plans, missed the mark this year

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At a time when investing for retirement seems more and more complicated, target-date retirement funds are uber-popular: Target-date funds are a simple way to own a diversified portfolio of stocks and bonds that gradually gets more conservative. The closer you are to retirement, the less risk the fund will take — a sensible strategy that has attracted $3.27 trillion, or 42 percent of all 401(k) plan assets. 

But the strategy hasn’t worked out well so far this year for those whose target-date funds aim for retirement in the next several years. As of July 1, 2022, Morningstar reports that the average 2025 target-date fund is down by 14.64 percent. That’s nearly three times the drop as in the worst full year over the past decade. Though funds with later retirement dates did even worse, at least those investors should have time for markets to recover before they have to withdraw. When you combine these losses with the 8.6 percent inflation over the past year quickly evaporating purchasing power, retirement isn’t looking very good. What gives?

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Morningstar reports that the five largest target-date fund families are T. Rowe Price, Vanguard, Fidelity, American Funds and BlackRock. Their 2025 target-date funds hold between 48 and 58 percent in stocks. It’s not exactly a surprise that they would have losses during a bear market for stocks, but the magnitude of the losses does surprise me.

I view bonds as the culprit. Normally, bonds act as a shock absorber in a bear market. Not this time. The average intermediate-term core bond fund has lost 9.99 percent this year through July 1, according to Morningstar. Jason Zweig reported in The Wall Street Journal that this is the worst start to the bond market since 1842.

(Bond prices fall when interest rates rise: No one wants a bond yielding 2 percent when newly issued bonds yield 3 percent. In the first half of 2022, the yield on the bellwether 10-year Treasury note nearly doubled.)

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What does this mean going forward?

All bear markets are different. The previous three bears were caused by an internet bubble, a financial crisis and a pandemic. This bear market was caused by inflation and rising interest rates. The high inflation is global due to supply chain issues from the pandemic and Russia’s invasion of Ukraine.

It’s pretty widely accepted that no one can predict the stock market, which has a long history of making fools out of those who try. Yet I’ve found that many people think they can predict the bond market. It turns out that economists can’t predict inflation, interest rates or even the economy. The Federal Reserve controls the overnight interest rate, but markets control intermediate and longer-term rates. Those intermediate and longer-term rates increased with higher inflation expectations.

The good news on those higher interest rates is that the bond portions of these target-date funds are now yielding much more than at the beginning of this year. That is income we can live on. So while it’s been a rough ride for target-date funds, I think the death of balanced stock and bond portfolios, such as in target-date funds, has been greatly exaggerated.

Cash is guaranteed to lose spending power in inflationary times, and I’m not recommending alternative investments like cryptocurrencies, gold or commodities.

Advantages and disadvantages of target-date funds

Target-date funds simply harness the most powerful force in the universe — inertia. With one simple fund, you can own a diversified portfolio that will automatically rebalance between stocks and bonds, and also get more conservative the closer you get to retirement. All you have to do is nothing.

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But there are some disadvantages as well. Target-date fund fees are higher than just directly holding the underlying investments. The overall allocation may not be what you want or need, although you can adjust that by simply picking a target year that is either earlier or later than the year you plan to retire. Finally, if you have a significant taxable portfolio in addition to a tax-deferred retirement account, you can be far more tax efficient by having more of your stock funds in your taxable account and bond funds in your tax-deferred accounts.

How to pick a target-date fund

If you are currently employed and hold your target-date fund within your 401(k), you may not have a choice of what fund family to use. Some 40(k) plans do allow in-service rollovers to IRAs and all will allow you to do so when you separate from your employer.

When you do have a choice, make sure you pick a fund with low fees. This Morningstar website shows the annual expense ratios. The more you pay in fees, the lower your return is likely to be. Fidelity, State Street and Vanguard have some funds that charge 0.12 percent annually or less. Then look at the allocations between stocks and bonds and make sure you are comfortable. Even though bonds are having their worst start since the Tyler administration, they are still doing far better than stocks.

Never forget that stocks lost over 20 percent in one day on Black Monday in 1987. I still argue that stocks have more risk in a day than bonds have in a year. 

Once you select the target-date fund, it’s critical that you stick to it. Then, all you must do afterward is nothing.

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