It’s no secret that U.S. stocks have continued to rally in 2013, up more than 15 percent for the year as of mid-August. Yet as many workers open their 401(k) statements, they may be disappointed by the returns they’re seeing, particularly if they’re older workers invested in a target date fund–that premixed bundle of funds available in more than half of 401(k) plans today.
Among 2020 target date funds (intended for workers who expect to retire around that year), the 45 funds we checked lost an average of 1 percent in the 2nd quarter of 2013. Only two of the funds eked out a gain, and the worst fund lost 4.74 percent. And for the first six months of 2013, these funds had an average return of little more than 3 percent, 10 percentage points fewer than that of an S&P 500 stock index fund for the same period. Still this is a far cry from 2008, when some especially aggressive preretirement target date funds lost as much as 40 percent for the year.
Look at how much target date funds are costing you in the September issue of Consumer Reports.
The culprit? Bond funds. Target date funds become more conservative as they age, tilting away from stock funds and toward bond funds. On average, the 2020 funds hold about 40 percent of their assets in bond funds. (In comparison, 2040 target date funds, designed for younger workers, hold only about 10 percent of their investments in bond funds). So when bonds began selling off this year, they dragged down the value of the bond fund component of these target date funds.
But one can also blame–or, as we prefer to do, credit–diversification. Target date funds aren’t designed to anticipate short-term directions in either stock or bond markets. Rather, they attempt to optimize a portfolio based on the time horizon of the investor. In the case of the 2020 target date fund investor, who only has a few years remaining until retirement, preserving existing savings becomes more important than growing savings. By having a greater exposure to bonds, one minimizes (but does not eliminate) the downside by having some savings in an investment less volatile than stocks.
– Chris Horymski
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