Hypocrite: A person who pretends to have virtues, moral or religious beliefs, principles, etc., that he or she does not actually possess, especially a person whose actions belie stated beliefs. A hypocrite only pretends to care about participants.
Confused: Fiduciaries say they want to protect those near retirement, but this is a “pure heart but empty head” statement since participants are not protected in target-date funds as they approach retirement. Mistakes can ruin participant retirements.
Recent surveys of plan sponsors and their advisors report that the responding fiduciaries want to protect plan participants against losses as they near retirement. A Met Life survey reports “seven in ten plan sponsors are concerned about the impact of market volatility on those near or in retirement.” And a recent PIMCO survey reports that advisors want to protect those near retirement against losses of 10% or more.
Yet most of these fiduciaries have selected risky target-date funds (TDFs) that will lose more than 10% for those near retirement in about 3 years out of 10, although you wouldn’t know it based on the recent past. The last 10 years have been incredibly lucky for target-date fund beneficiaries nearing retirement since the odds of avoiding losses in all 10 years with 85% in risky assets is only 5%, yet none of the past 10 years has experienced such a loss. Fiduciaries should not expect a repeat.
If you look, you will see
The most popular TDFs hold 85% in risky assets at the target date, considering equities and long-term bonds as being risky.
This is a mix that lost more than 30% in 2008 when bonds were far less risky.
The two types of TDFs
The TDF industry has differentiated glidepaths as “to” or “through,” but this is a distinction without a difference because some “to” funds are riskier than some “through” funds. A more meaningful classification is “safe” or “risky” at the target retirement date. Most TDFs are risky, but the Federal Thrift Savings Plan (TSP) is safe, with only 30% in risky assets at the target date. The TSP is the world’s largest savings plan.
The TSP is not alone. The TDF of the Office and Other Professional Employees International Union (OPEIU) is also less than 30% risky at the target date. And there is a benchmark for safe TDFs called the SMART Target Date Fund Index; it’s a normative benchmark — the way things ought to be.
Congress has taken an interest in TDFs and has asked the Government Accountability Office (GAO) to explain why the TSP glidepath is so safe while most other TDFs are risky at the target date. At $3 trillion and growing, TDFs are about a third of all 401(k) assets. They’re a big deal and getting bigger.
The importance of safety at the target date
Retirement researchers use two related terms: “Sequence of Return Risk” and the “Retirement Risk Zone.” Sequence of return risk is the fact that losses sustained early in retirement are far more harmful than losses sustained later in life. The Risk Zone is the 5 years before and after retirement when losses can devastate the rest of life.
Simply put participants cannot afford investment losses as they transition from working life to retirement. They want to be — and believe — they are protected when they default their investment decision to their plan sponsor.
Participant shock in 2008 led to the first and only joint hearing of the SEC and DOL to correct the TDF risk problem, but nothing happened. This time is different. There was only $200 billion in TDFs in 2008, far less than today’s $3 trillion. And 78 million baby boomers were not in the Risk Zone in 2008; they are now.
Would you rather be safe or lucky?
The past 13 years have been phenomenal. The stock market has had its longest recovery ever and has grown 600%. Investors have been extremely lucky.
But this is likely to change when we experience either inflation or deflation. There’s an ongoing debate about where inflation will move from here, which is near zero. It’s currently looking like it will move up and this will lead to a stock market crash. But the market will also crash if we get deflation.
As shown in the following classic Crestmont Research graph, stock markets do not fare well in both inflationary and deflationary environments because Price/Earnings ratios are low. History says investor fear dominates when we have high inflation or deflation.
If P/Es decline from the current 30 down to 15, the stock market will lose 50%; that’s just math.
Investors should not count on luck to protect them much longer. Fear has a history of crashing markets when inflation moves away from zero, up or down.
Hypocrite or confused?
The TDF industry has fallen into the misbelief that popularity is prudent, that choosing the most popular TDFs is required by procedural prudence. Yet fiduciaries ought to know that this choice is risky, and imprudent. Surveys confirm that fiduciaries want to protect those near retirement and might even think that they are but this “pure heart but empty head” defense fails in court.
The next market crash will create the harm that attorneys could seize upon to remedy the excessive risk in TDFs at their target date. Where there’s harm there’s a foul. Time will tell.
Conclusion
Most of our 78 million baby boomers will spend this decade in the Risk Zone, so I authored a book to help them—Baby Boomer Investing in the Perilous Decade of the 2020s. The chapter on target-date funds advises the reader to withdraw from their TDF as they near retirement and move to safety. This is a tall order for someone who does not want to make investment decisions.
The fact is that TDF participants near retirement will be seriously harmed in the next market correction, and most won’t recover. It’s sad because it should be avoided.
Ron Surz is President of Target Date Solutions and CEO of GlidePath Wealth Management. He is also the author of Baby Boomer Investing in the Perilous Decade of the 2020s. He can be reached at Ron@TargetDateSolutions.com.