Who suffers the most in an investment market crash? The logical answer to this question is that people with the most to lose—the rich—suffer the most. The bigger they are, the harder they fall.
Yet the target date fund (TDF) industry justifies high risk for the “rich” by stating that they can afford losses because their TDF made them rich by taking risk. “Rich” in this context is “rich as you will ever be because your working life is over.” This explanation is absurd, as I explain in this article. I also explain why TDFs are way too risky at the worst possible time in each participant’s life.
Everyone hates to lose money, whether rich or poor. The degree of suffering is personal. Bring out the pain meter.
Claiming false credit while denying responsibility
Wealth as we approach retirement is mostly the result of our savings. Returns on those savings help, but not that much. In other words, TDF providers cannot take credit for making anyone rich, but they should take responsibility for exposing lifetime savings to high and unnecessary risk at the worst possible time, in the transition from working life to retirement.
In fact, TDFs undermine the good efforts that plan sponsors employ to encourage savings through:
- Automatic enrollment
- Automatic escalation
- Employer matches
- Education
These actions address the “retirement crisis” where workers have not saved much. Whether these efforts succeed or not, risking lifetime savings undermines these good efforts. Those lifetime savings—both large and small—should be protected because that’s all there is.
The Risk Zone and Sequence of Return Risk
Retirement researchers have documented the worst possible time to suffer investment losses and have labeled it the “Risk Zone” that spans the 5 years before and after retirement. Losses sustained in the Risk Zone can ruin a retirement with dignity.
The criticality of these 10 years generates “Sequence of Return Risk” since this is the period when investment losses hurt the most.
Most TDFs ignore this risk. They are more than 85% risky in the Risk Zone, with 55% in equities and most of the balance in risky long-term bonds. This mix lost more than 30% in 2008 and is on a path to repeat those losses today. The absurd justification is that risk makes you rich.
Only a few TDFs actually protect in the Risk Zone, but they are not popular.
So, who suffers the most?
It’s not a matter of “who” suffers most. It’s a matter of “when” investment losses hurt the most. The pain meter is highest in the Risk Zone when both rich and poor suffer the most.
Everyone has a plan as they approach retirement. Some may see yachts while others envision doublewides. Reductions to those plans caused by investment losses are devastating, probably even more so for the poor.
Retirement with dignity is a universal objective.
SEE ALSO:
• Target Date Funds are Not Protecting Those Near Retirement
• Target Date Solutions Launches Software that Facilitates Personalized Target Date Accounts