The unthinkable has just happened. As shown in the following graph, people nearing retirement have lost more in their target date funds (TDFs) than those who will retire decades from now.
That’s not supposed to happen—those near retirement are supposed to be protected while younger participants are supposed to be risk takers.
The Industry’s 2020 funds for those near retirement have lost 11.6% in the year ending August 19, 2022. At the same time, the 2060 fund for people retiring in 40 years lost only 7.9%. In contrast, other indexes show less shocking results that I discuss in the following.
Those near retirement cannot afford investment losses because they are in the “Risk Zone” when losses reduce the standard of living in retirement. PIMCO’s surveys of consultants report that a loss of 10% or more is extreme and unacceptable for those near retirement. An 11.6% loss is extremely unacceptable; it’s a big deal.
This past year has been painful for TDF investors near retirement, especially in contrast to those who can afford investment losses, namely beneficiaries retiring in 40 years.
This surprise has never happened before because bonds have consistently outperformed stocks in down stock markets until now.
Source: Target Date Solutions
Two types of target date funds: Safe and Risky
The popular “to” or “through” label is a distinction without a difference. Too many “to” funds are riskier than many “through “funds at the target date. “Safe” or “risky” at the target date is a much more meaningful distinction.
The results for the “Industry” in the graph above uses the S&P TDF Index, a composite of all TDFs. Most of the assets and funds in this index are “risky” at the target date, with 85% in risky assets, namely equities plus long-term bonds. Morningstar recently warned about the high risk in these funds, and there is a Congressional inquiry into TDF risk.
By contrast, the SMART Index is for the” Safe” group of TDFs represented by the Federal Thrift Savings Plan (TSP) and the Office Professionals Union OPEIU. The TSP is the largest savings plan in the world, with $800 billion, and OPEIU is one of the largest AFL-CIO unions.
Rounding out the trio of indexes in the exhibit, the Dow methodology allocates to stocks, bonds, and cash using optimization to control downside risk. Curiously, all vintages report the same 7.1% return but note that this is between the Industry (Risky) and SMART (Safe) indexes.
The Risky group’s 2020 funds have disappointed because they are high risk and use bonds to defend. In contrast, the Safe group is not risky and uses much safer defenses like Fund G (government guaranteed against loss) for TSP and Stable Value for OPEIU.
Asset class returns for the year ending 8/19/22 are shown in the following exhibit. All asset classes lost value except Stable Value.
More to Come
Although this is the first time near-dated funds have lost more than long-dated funds, it won’t be the last. Similarly, it’s the fifth time near-dated Safe TDFs have outperformed Risky, but it won’t be the last. Previous instances include 2008, 2011, 2018, and Q1 2020. Expect more outperformance from now on.
As explained in ”Now You Know … the Rest of the Story,” there are many reasons to expect crashes in the stock and bond markets compounded by inflation and geopolitical upheavals.
The roaring 2010s have set the stage for the depressing 2020s when Safe TDFs are protecting, much like the Roaring Twenties set the stage for the Great Depression.
Conclusion
This underperformance is a wake-up call and the beginning of the unraveling of flawed TDFs. Most TDFs do not provide the protection that defaulted beneficiaries need and deserve. Like the excessive fee scandal, the excessive risk reality will be exposed in the imminent market crashes and remedied by lawsuits and beneficiary rebellions.
Incentives modify behavior and come as carrots and sticks. The carrot, in this case, is good employee morale. Happy workers are good workers. Sticks are the lawsuits, and they always work.
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.
Ron Surz is CEO of Target Date Solutions (TDS), co-host of the Baby Boomer Investing Show (BBIS), and author of the book "Baby Boomer Investing in the Perilous Decade of the 2020s." TDS licenses target-date fund usage of Ron’s patented Safe Landing Glide Path® (SLGP) that actually protects beneficiaries as they approach retirement. Individual investors can follow the SLGP at Age Sage, an educational interactive website. The BBIS educates baby boomers on the risks and rewards in contemporary investing, and Ron’s book is a tour of these shows. He can be reached at Ron@TargetDateSolutions.com.
Matthew Eickman wrote a white paper about this almost ten years ago called Missing the Target, predicting many of these issues before anyone noticed their flaws. It’s sad to see advisors just chase low expenses and allow TDFs to run plans. Anyone that is paying attention should know that Millennials are far more risk adverse than their parents, meaning that they should not be defaulted into equity heavy funds if they’re just going to pull out from shock of seeing negative statements. Risk Based with upfront risk assessments should be mandatory.
Thanks Scott. I didn’t know about Matthew’s article. Since we’re sharing, I co-authored a book on TDFs that also warned. Te book is “The Fiduciary Handbook for Selecting Target Date Funds”
Ron, have you done the math to see what the upside is after 10 years, and then the short term down period and see where total wealth is? It would be interesting to see this math. Can you run these numbers from say 7/1/2013 through 6/30/22 to see what the math shows….you could argue use that version early and then switch within 5/10 years of retirement.