If you recently retired or are near retirement and you had your money in a target-date fund designed for people retiring about now, bad luck.
So far this year, the “target” is you.
Morningstar tells me the average such “2020” target-date fund has lost 11.6% of its value since the start of the year. That kind of portfolio loss is painful enough for younger people still accumulating money for golden years that are decades in the future. But for someone who has just stopped work, and who is at their peak level of accumulated savings, it is no joke whatsoever.
“While target-date funds are a good, simple, one-stop-shopping solution for many investors, they cannot hide from what is happening in the markets,” explains Mari Adam, a wealth adviser at Mercer Advisors in Boca Raton, Flo. “Keep in mind a target portfolio is just a mix of stocks and bonds. Unfortunately, so far in 2022, stock markets are down and bond markets are also down.”
The plunge in the value of these funds isn’t because of their execution but their fundamental strategy. These funds typically shift from “risky” stocks to “safe” bonds as you near retirement. And that usually makes sense, because bonds are usually safe. Uncle Sam will pay his bills, so if you own Treasury bonds you will get the interest and principal. Blue-chip corporations generally do so as well.
The real problem? Simple. When it comes to investing, price matters.
By the start of this year bonds had become so expensive that 10-year Treasury notes
sported yields (interest rates) of just 1.6%, 30-year Treasury bonds
yielded just 2%, and all “inflation protected” Treasury bonds
were actually guaranteed to lose purchasing power, no matter how long you held them.
Money managers will tell you that going all the way back to the 1920s, 10-year Treasury notes have produced an “average” annual return of 5%. And they’re right. That’s because the average interest rate on those bonds has been, well, about 5%.
How do you get a 5% annual return out of your bond when it only has a 2% interest rate? You can’t. Good luck trying.
Going back to the 1920s, 10-year Treasury notes have on average earned you about 2.3% more than the rate of inflation. How can a bond paying 1.6% interest beat inflation by 2.3% a year? Answer: Only if inflation is actually negative, year after year—something that has only happened during the depths of the Great Depression.
(And if that happened, by the way, good luck with your stocks.)
Treasury bonds became so expensive that instead of offering “risk-free return,” which is what investors usually want, they essentially offered “return-free risk.” The interest rate was so far below the prevailing rate of inflation that these bonds were going to end up costing you money in real purchasing power terms. Meanwhile, if the Federal Reserve decided to start raising interest rates, existing bonds were going to fall.
After all, who wants to lock in a 1.6% interest for the next 10 years when the money markets will now pay you 3% a year?
No wonder the U.S. bond market index
is down about 10%, the 10-year Treasury note
11%, and supposedly super “safe” long-term Treasury bonds
as much as 30%. Even inflation-protected Treasury bonds
have fallen about 7% on average.
The only surprise about this year’s bond rout is that it took so long. Maybe in due course the Fed will reverse strategy and launch another round of “quantitative easing.” There again, maybe not.
For those stuck in target-date funds, here’s the good news: The investment opportunities open to retirees are better than they were.
For instance, this year’s bond rout has sent interest rates shooting higher. The 10-year note now yields nearly 3% and longer-term Treasurys yield more than 3%. (Bonds are like seesaws: The price falls when the yield or interest rate rises, and vice versa.)
It’s still dismal compared to inflation, currently running above 8%, but at least it’s better than it was. (And inflation is expected by the bond market to fall back sharply pretty soon.)
Investment-grade corporate bonds look better
with average interest rates nearing 5% according to Federal Reserve data.
Inflation-protected TIPS bonds now pay more than inflation. Long-term TIPS bonds
are guaranteed to beat official inflation by as much as 0.6% a year for 30 years.
Maybe the best news for retirees facing a crunch is that annuity rates, following corporate bond yields, have jumped sharply so far this year.
Annuities are contracts issued by insurance companies that promise to pay you a fixed amount a year until you die, whether that’s tomorrow or in 2100. They are a solid product for those trying to squeeze the most retirement income out of their savings. Annuity payout rates for, say, a 70-year-old woman have jumped about 10% in less than a year. They may yet go higher still—nobody knows—but they are worth a look.