Many Americans have spent the past decade putting more of their retirement money into target date funds, a set-and-forget type of investment product touted as an easy way to invest in a diversified portfolio. of stocks and bonds. The product works by switching from stocks to bonds over time, providing the investor with a more conservative mix as retirement age approaches.
But many of these funds are turning to bonds more slowly than a decade ago, after managers loaded up on stocks.
The portfolios of younger workers now invest 92% of contributions in equities, up from 85% a decade ago, with some top-selling target date funds approaching 100% in equities early in an investor’s working life, according to Morningstar Inc.
Mid-career workers have seen the biggest increase in stock market exposure, with portfolios for 45-year-olds now holding 82% stocks, down from 69% a decade ago, and far more aggressive than the portfolio traditional 60/40. At retirement age, median exposure is now 46%, up from 43% in 2011. These numbers are based on median exposure at different ages among the dozens of target date funds tracked by Morningstar.
For more than a decade, the strategy has been a boon to investors. Stocks jumped, as did pension balances. But now, with the S&P 500 Friday closing around 19% below its peak, the strategy faces a test.
“It will be interesting to see if investors are able to hold on to the higher volatility in these portfolios or if they start selling, which could cause them to miss a bounce,” said analyst Megan Pacholok, an analyst who follows. target date funds. at Morningstar.
She expressed particular concern for older investors given that they don’t have as much time to catch up with market declines.
“If you’re 30 and saving for retirement, you have time to weather a longer bear market and recover, but for retirees it may be a different story,” Ms Pacholok said.
The combination of target date investments is critical to the success of millions of Americans, not just today’s retirees. These funds hold approximately 40% of the total assets of 401(k)-style plans administered by Vanguard Group, up from 12% in 2010. They attract 60% of new contributions to 401(k) plans.
Some fund managers started moving into more equities several years ago. They said the strategy should help investors build more wealth for retirement because stocks have historically outperformed bonds over long periods of time. Notably, bonds have recently provided little help against equity performance.
“Stocks have been in freefall since the global financial crisis of 2007-2009,” Ms Pacholok said. “Solid markets have consistently punished investors for rebalancing stocks.”
Fund managers cite a different motivation: their faith in data that shows savers in target date funds tend to leave their investments alone through good times and bad.
Researchers at Vanguard — the largest provider of target-date funds, with about $1 trillion in such funds — found a drop in transactions in the 401(k) plans it administers. In 2020, 10% of participants with Vanguard 401(k) accounts traded, up from 20% in 2004.
Through the end of April, 3.3% of the 4.7 million people who hold 401(k) accounts at Vanguard have made transactions. Target date investors are even less likely to touch their accounts. In total, 0.9% of savers in target date funds made trades, a figure that increases slightly to 1.2% for those aged 55-65. The trading rate is roughly unchanged from a year ago, according to Vanguard.
The lesson some fund managers have learned from this investor resilience is that they can plan for the long term.
“People don’t make emotionally-driven, often misguided decisions” in response to market volatility, said Dave Stinnett, retired head of strategic consulting at Vanguard.
In 2021, Vanguard gave retirees of its 401(k) target date funds the option to stick to a 50% equity allocation throughout retirement, rather than tapering to 30. %, provided their employer chooses to offer this feature.
Over the past two years, T. Rowe Price, the third-largest provider of target date funds, has increased equity allocations in its series of target date funds: T. Rowe Price Retirement and T. Rowe Price Target .
The Company’s Retirement Series now invests 98% of younger workers’ contributions in stocks, up from 90% previously. Workers 20 years from retirement hold 95% of the shares instead of 85%. Many retirees also have more shares. For example, 70-year-olds hold 51% of shares, compared to 46% previously.
Wyatt Lee, head of target date strategies at T. Rowe Price, said the decision was driven in part by data indicating individuals aren’t saving enough for retirement and need the extra returns they can get. by holding a higher proportion of their savings in stocks for longer periods of time.
The company also believes stocks can help protect against inflation and longevity risks, he said.
So far, investors have shown no signs of discomfort with T. Rowe Price’s decision. In the first quarter of 2022, the company said 0.4% of its target date fund investors had traded. When the coronavirus crisis hit in the first quarter of 2020, before T. Rowe Price phased in its higher equity allocations, 1.5% of investors in its retirement funds initiated trades.
“We saw that we could increase equity exposure without many participants taking their money out of the funds,” Lee said.
BlackRock Inc., the world’s largest asset manager, increased equity exposure in its LifePath target date series nearly a decade ago. The company’s asset allocation model had always started with 99% equity for younger investors, said Nick Nefouse, head of retirement solutions and target date funds.
The company has primarily increased equity exposure for mid-career workers. Portfolios for 40-year-olds now contain 95% equities, up from 80% previously.
BlackRock made the change in response to research from the University of Michigan showing American workers on average earn more than BlackRock originally estimated, giving them the ability to handle more risk, Nefouse said. .
Since enacting the change, he said, BlackRock has not experienced an increase in outflows of funds during periods of market turbulence.