In case you didn’t notice, all vintages of target-date funds lost about 5% in the first quarter of 2022. That is, funds for those near retirement lost as much as funds for those 20 or 40 years away from retirement.
That’s not supposed to happen People near retirement are supposed to be more protected against losses than those with a long time to retirement. That’s the purpose of a glidepath—to protect as retirement approaches.
So, what happened? Stocks and bonds lost about the same in the first quarter, about 5.5%. This phenomenon is a wake-up call.
Bonds are not safe today, certainly not as safe as they were when TDFs were originally designed.
The TDF industry protects with bonds. By contrast, the “SMART” row in the above graph shows TDFs that defend with very safe short-term Treasuries. It’s similar to the Federal Thrift Savings Plan (TSP) that protects with a government-guaranteed G Fund.
Not safe
The following chart takes the view that bonds are risky, so TDF allocations at the target date are about 85% risky, much riskier than most believe. Surveys of beneficiaries in TDFs report that many believe they are guaranteed against loss
By contrast, the TSP is only 30% risky, guarding against losses.
Near-dated 2020 funds are somewhat safer than long-dated TDFs, but not much. Funds for those retiring in 30 years (2050 Funds) are about 95% risky at the target date.
What next
The Federal Reserve is abandoning its Zero Interest Rate Policy (ZIRP) in order to fight inflation. This will result in increasing interest rates as the Fed takes its foot off the brake, and the increases in interest rates could burst the stock market bubble.
Like the first quarter, we can expect many more periods ahead of stock and bond losses, so TDFs will continue to lose money.
And we could see periods where those near retirement lose more than younger beneficiaries. This will happen when bonds lose more than stocks, as exemplified in the next chart.
The chart assumes stock losses of 5%, as occurred in the first quarter. Moving from left to right:
- If bonds outperform with zero loss, the 2020 fund defends relative to the 2050 fund
- If bonds lose as much as stocks, as just happened, the 2020 fund loses as much as the 2050 fund
- If bonds lose more than stocks, the 2020 fund loses more than the 2050 fund,
Conclusion
Near-dated TDFs might not defend as advertised in a period of rising interest rates, which is a reasonable expectation in light of Fed tapering that allows interest rates to seek a natural level. Over the long run, bonds have been priced to yield 3% above inflation, which is 10% in a 7% inflationary environment.
This would be an 8% increase from current levels that would cause bond prices to decline by 48% since duration is currently six years.
Beware the risk in bonds.
Ron Surz is President of Target Date Solutions, a DBA of PPCA inc. He is also the author of Baby Boomer Investing in the Perilous Decade of the 2020s. He can be reached at Ron@TargetDateSolutions.com.