Buddha said, “Impermanence is eternal.” The first quarter of 2025 has brought us a rare event: the US stock market actually underperformed most asset classes. Coming into 2025, the US stock market had an amazingly good 15-year run when concentration won handily over diversification because 100% in the US stock market was the place to be. But that tide has turned so far this year.
As Warren Buffet observes, as the tide moves out, we see who has been swimming naked—unprotected. In this case, target-date fund participants are not protected by diversification, so they’re exposed to concentration in US stocks and bonds, and participants near retirement are also unprotected from sequence of return risk.
The first and last wake-up call to these exposures was in 2008; 17 years is plenty of time to erase bad memories, plus younger generations never felt the pain. “Those who cannot remember the past are condemned to repeat it.” – philosopher George Santayana
After enjoying 15 years when risk was rewarded, these good times may be ending. Stein’s Law is “If something cannot go on forever, it will end” – Herb Stein, Senior Fellow at the American Enterprise Institute
TDF Performance
Regardless of whether this is the beginning of the long-anticipated crash or just a transitory hiccup, investors in the $4.5 trillion target date fund (TDF) industry should take heed. As recommended in this article about glidepaths, “Review how the fund has performed during past market downturns to gauge its resilience.”
Until now, diversification actually undermined TDF performance, but that just changed. Here’s how TDFs have performed so far in 2025. The diversified SMART Target Date Fund Index outperformed the Industry in the quarter, after lagging for the previous 5 years.
The SMART Target Date Fund Index follows my Safe Landing Glidepath (SLG) that is (1) much safer than the Industry at the target date, and (2) much more broadly diversified. The SMART TDF Index is available on Morningstar Direct.
SMART is a “normative” index setting a standard for the way TDFs should be, and providing a benchmark for evaluating performance. It’s a benchmark that is easy to beat when risk is in favor, and hard to beat now, as well as 2008 and 2022. Yes, it’s my opinion of what TDFs should be; I think that diversification and protection against sequence of return risk are good things.
Here’s the SMART financial engineering designed to deliver defensive growth. SMART protects with a Reserve Asset of T-bills and short-to-intermediate-term Treasury Inflation-Protected Securities (TIPS).
The Industry is the S&P Target Date Fund Index that is an aggregation of all TDFs. It is a consensus index—the way TDFs actually are, in contrast to a normative index of what they should be. Sometimes common practice is not prudent practice, in which case lawsuits can correct the harm like they did with excessive fees.
Diversification beyond US stocks did not work for the 15 years coming into 2025 because US stocks were the big winners. But that has flipped in Q1 2025. Most other assets are now outperforming US stocks, so diversification is working again.
Q1 2025 TDF performance is flat—near zero across target dates—so Q1 is not a big test of diversification, yet. Diversification has added about 2% to TDF performance so far this year.
The reason for SMART’s recent better performance is risk management.
Risk Management
TDFs can and should be more prudent—more protective and more diversified. Most TDFs take high risk at the target date, and they are mostly US stocks and bonds, so they are not diversified. Here’s how the risk and diversification of the TDF Industry compares to SMART.
So why am I showing you this? Until recently, there has been very little improvement in TDFs since their introduction to 401(k) plans in 2006. The most recent innovation is personalization that I discuss below, but there is a crying need for more basic improvements in prudence.
The primary innovation that really needs to happen—but has not—is protection, especially at the target date. The Industry does not protect against Sequence of Return Risk. Also, the Industry says it follows academic Lifetime Investing Theory, but it does not; the Theory is very safe at the target date—much safer than the Industry. Here are comparisons of SLG glidepaths to the Industry.
The U shape in the above glidepaths is unique and designed to (1) manage sequence of return risk near retirement, and (2) extend the life of assets in retirement by re-risking, following the guidance of Kitces and Pfau. Note that these paths are both “To” and “Through.” By definition, “To” reaches its lowest equity allocation at the target date and “Through” serves through the target date to rest of life.
Other Prudent Glidepaths
This February Great Gray Trust Company purchased the Retirement Plan Advisory Group (RPAG), provider of flexPATH that has attracted $50 billion to their TDF set of three glidepaths that hold a diversified group of 27 CITs. The High risk glidepath in the following graph is like the Industry.
It’s a great success story, and a credit to the RPAG designers—Congrats!!
Plus, there’s the $850 billion Federal Thrift Savings Plan (TSP), the largest savings plan in the world. The TSP defends at the target date with 70% in the government guaranteed G fund.
The TSP and flexPATH glidepaths are similar to the Safe Landing Glidepaths but they do not re-risk in retirement. The point is that there are in fact other prudent glidepaths that have been very successful. Even greater success will follow the next stock market crash. It is likely that Q1 is just the beginning of more to come.
More to Come?
One quarter is a short period of time. The recent setback in the US stock market might be just a hiccup, but there are reasons to think that a real crash is brewing. The US stock market is extremely expensive, so some prominent investment management firms like GMO and Vanguard are forecasting more disappointment ahead. Howard Marks observes that, “It should not come as a surprise that the return on an investment is significantly a function of the price paid for it.”
And of course, there are concerns about the consequences of new tariffs starting in April. The previous Smoot-Halsey tariffs of 1930 worsened the effects of the Great Depression, but that was 95 years ago. Is this time different?
Buckle up. A recent innovation can help. It gives individual participants the wherewithal to protect themselves, but it is being oversold, as discussed next.
Personalized Target Date Accounts (PTDAs)
Several TDF providers have come to market with PTDAs as a qualified default investment alternative (QDIA), but you cannot actually “manage” an account for someone who will not talk to you, as is the case for those who default their 401(k) investment election.
PTDAs have merit when they are provided to self-directed participants because non-defaulted people do want to engage.
As for defaulted participants, the PTDA framework can be used by plan sponsors to customize their “one-size-fits-all-set-it-and-forget-it” TDF to workforce demographics, using a “Master” PTDA. In other words, customized one-size-fits-all works as the QDIA, and is an improvement over non-customized off-the-shelf.
PTDAs for self-directed people are non-QDIA managed accounts. PTDA software is used by plan sponsors to construct and maintain custom target date funds as the QDIA.
Importantly, the best PTDAs use managers selected for their superiority, as opposed to exclusively using the proprietary managers of a TDF firm. Also, PTDAs report individual fund holdings rather than a target date cohort like “The 2050 Fund,” and the target date is the actual month that the participant intends to retire.
Coming Soon: Fixing TDFs
2008 was the first and last time that participants screamed for repair to TDFs because they lost more than 30%—TDFs were way too risky. But nothing changed in the next 15 years, and that worked very well because risk, especially US stock market risk, was handsomely rewarded.
Since “nothing was broken,” nothing needed fixing. But TDFs are broken in ways we only see when risk management pays off during stock market crashes. Like casualty insurance, you don’t need risk management until you do. Unlike 2008, this time 78 million Baby Boomers are in the Risk Zone when Sequence of Return Risk can ruin the rest of life; many will not live long enough to recover from the next crash—“Stocks for the long run” doesn’t work for them.
Prudent safety and diversification are the fixes that I recommend in my new book that I’ll release when the market crashes. No one will read my book until they see that TDFs are in fact broken, but I’m happy to send you a free eBook in the meantime if you’re interested.
My normative (the way TDFs should be) SMART TDF Indexes are substantially different from the consensus (the way TDFs are) S&P TDF Indexes. Risk management is the difference. Risk was highly rewarded over the past 15 years. That will not last.
Conclusion
Q1 2025 is a minor stress test of TDFs. It’s too soon to tell where recent US stock market setbacks are heading, but we can examine the effects of this disappointment on TDFs, the most popular QDIA. No surprise, concentration in US stocks and high allocations to US stocks at the target date create concerns, especially for those near retirement because TDFs do not protect against Sequence of Return Risk.
TDFs need to be fixed, so I’ve written a book that explains why and how. We’re watching the warning signs now. There’s more to come. Fear and greed drive the stock market. CNN Business reports that extreme fear is the current mindset:
• To request a free ebook, contact Ron Surz at ron@targetdatesolutions.com.