In 2008, investors were shaken when many in or near retirement saw a significant percentage of their 401(k) balances disappear. Even those in so-called target-date funds, generally designed to minimize large swings close to retirement, saw losses of 25% or more.
This time, amid fears of a global economic slowdown tied to the spread of the coronavirus, the hit to those investors hasn’t been nearly as large. That is, of course, so far. It’s still impossible to know how much more damage we might be in for.
The path to retirement bliss
During the 2008 financial meltdown, target-date portfolios for people planning to retire by 2010 plunged by 36% on average from the market’s precrisis peak on Oct. 9, 2007 to March 9, 2009, when stocks began to rebound, according to Morningstar Direct, a database from Morningstar Inc. In contrast, from Feb. 20 through Thursday, such portfolios for people planning to retire in 2020 fell close to 13%, on average.
From Feb. 20 through Thursday, the S&P 500 stock index (.SPX) declined 27%. Friday’s rebound reduced the drop to about 20%. The index fell a cumulative 55% over the financial-crisis period.
During the financial crisis, the 36% loss by near-retirees in target-date funds represented more than two-thirds of the 53% decline suffered by workers who were 30 years from retirement. By contrast, losses by people close to retirement today are about half of the 24% decline posted by funds for workers who expect to retire around 2050.
Over the past decade, due in part to lessons learned during the financial crisis, “the target-date fund industry has matured significantly,” said Leo Acheson, a director at Morningstar Inc. who follows target-date funds. Approaches to and philosophies about asset allocation and risk management “have become more sophisticated.”
Target-date funds, which take an increasingly conservative approach as you near retirement age by reducing stockholdings in favor of bonds, are core offerings in 401(k) and other workplace retirement plans, and held about $2.3 trillion in assets as of the end of 2019.
The all-in-one funds have become staples in workplace retirement plans thanks to a 2006 law that sanctions their use as default investments for employees who are automatically enrolled.
Target-date funds for people close to retirement “are holding up better, which is important given that this is when nest eggs are biggest and it’s really important to preserve them,” said Mr. Acheson.
The spread of automatic enrollment has driven a surge into these funds. They accounted for 37% of the assets in 401(k)-style plans Vanguard Group administered in 2019, up from 12% in 2010. Target-date funds attracted 59% of new contributions to 401(k)-style plans last year, according to data on plans Vanguard administers.
As they have become more popular, these funds have also become “more homogenous,” Mr. Acheson said.
In 2008, funds with similar target dates posted widely divergent results due, in part, to differing approaches to risk management. While a 2010 fund in a series from Wells Fargo (WFC) that invested conservatively lost 11% that year, for example, the Oppenheimer Transition 2010 fund—saddled with soured bets on mortgage-backed securities—sank 41%.
Since then, the performance gap has narrowed considerably, amounting to about 13 percentage points for 2020 portfolios during the recent stock market selloff through Thursday, according to Morningstar. While the Putnam RetirementReady 2020 fund (PMRGX) lost 4.63% between Feb. 20 and March 12, the T. Rowe Price Retirement 2020 fund (RRTBX)—which has a significantly higher allocation to stocks—declined 17% in that period.
Many target-date funds, including the T. Rowe Price 2020 fund (RRTBX), are designed for people to stay in after retirement. Joe Martel, a target-date portfolio specialist at T. Rowe Price Group Inc. (TROW), said target-date funds are “meant to be held for decades.” The company, Mr. Martel added, believes “the level of equity in our target-date funds is necessary to help investors overcome the risk of running out of money in retirement.”
According to Morningstar, the T. Rowe Price Retirement 2020 (RRTBX) portfolio is ranked in the top percentile of funds in its category over the past 15 years.
One reason target-date funds for those close to retirement have been able to offer better protection in down markets this time is that many have revamped their asset-allocation models and approaches to managing risk since 2008, said Mr. Acheson. Portfolios closest to retirement have an average of 45.3% in stocks now, down from 50% in 2009, according to Morningstar.
To try to avoid losses or enhance gains, some funds sponsored by companies including Fidelity Investments and BlackRock Inc. (BLK) have given managers some flexibility to deviate from asset-allocation models, by modestly raising or reducing the percentage of assets in stocks or bonds in response to market conditions, Mr. Acheson said.
At T. Rowe Price, the third-largest target-date fund provider with $292 billion in such funds as of Dec. 31, fund managers since 2002 have had the ability to deviate from asset-allocation targets by “plus or minus 5 percentage points,” said Mr. Martel.
This has added 0.14%, on average, to annual returns over that period, he added. The target-date funds were 0.5 percentage point overweight in stocks before the market decline and are now 1.5 percentage points overweight, he said, to take advantage of stocks’ lower prices after the selloff. Of course, such a strategy may prove premature if stocks fall further.
Since 2017, T. Rowe Price has added long-term Treasury bonds to its target-date funds, providing some protection against stock-market declines. Treasury securities have generally held up well in recent days.
Some target-date funds have also added exposure to niches within the stock and bond markets in recent years, including emerging markets and high-yield bonds. The goal is to reduce risk by enhancing diversification.
In 2013, Vanguard, the largest player in the target-date market with $831 billion under management as of Feb. 29, added international bonds to those portfolios, said Brian Miller, a senior product manager in the portfolio-review department, which oversees the company’s funds. The company eliminated cash and switched the funds’ Treasury inflation-protected securities exposure to a shorter-term portfolio, which provides better protection against unexpected inflation.
Returns may also vary less from one fund to another because a greater number of target-date series now use index funds to some extent, Mr. Miller said.
With more assets flowing into index-based target-date funds, fewer managers are making large bets that may result in performance that significantly differs from the benchmarks, said Mr. Miller.
He noted that some of the funds that fared poorly in 2008, including the Oppenheimer Transition funds, are now gone.
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