Hugely Popular Retirement Investments Flop in Bear Market

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.

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.