Interest rates are rising and will keep rising for some time. Or put another way, bond prices are falling. Bonds are not safe. And because target-date funds (TDFs) use bonds as their “safe” asset, TDFs are not safe.
TDF glidepaths are supposed to protect beneficiaries as they near retirement. Most TDFs protect with bonds, as shown below.
Most TDFs are more than 50% in equities at the target date and more than 30% in bonds that are now risky, so about 85% risky at the target date. The Federal Thrift Savings Plan (TSP) is a notable exception that Congress has asked the Government Accountability Office (GAO) to review. The TSP is 70% safe in government-guaranteed Fund G at the target date.
Investors in target-date funds need to prepare. It’s ugly and going to get uglier.
Recent performance
So far this year, near-dated TDFs are losing about as much as long-dated because stocks and bonds have lost about 5%. Some have written that bonds are now correlated with stocks, which is not good.
More to come
In its efforts to fight inflation, the Federal Reserve is raising interest rates and tapering its bond-buying program for its Zero Interest Rate Policy (ZIRP). The end of ZIRP is the end of manipulated low interest rates.
In normal times, bonds are priced to yield 3% above inflation, which is 11.5% when inflation is 8.5%. Bond yields are headed above 10% unless the Fed can get inflation below 7%.
An 8% increase from the current 2% to 10% will cause bond prices to plummet 48% because the duration is six years. The year-to-date 5% bond loss is just the beginning.
A first time
Bonds have never before failed to defend in a falling stock market. Bond returns have exceeded stock returns in every year that stocks lost money.
That’s why TDFs have relied on bonds as a safe asset, but this time bonds will not protect.
Conclusion
Seventy-eight million baby boomers will spend this decade in the Risk Zone spanning the five years before and after retirement when investment losses can irreparably spoil the rest of life.
Those in TDFs should take back control by not defaulting and moving to safety.
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.