Shelter-in-place orders are in effect for approximately 90% of the U.S. population. Much of the economy has abruptly stopped and there is so much to manage amid uncertainty in business and personal life.
As you navigate the many competing objectives, our posts here are intended to provide short two-minute reads relative to the retirement plan. The thought for today is a simple one about retirement plan investment options in the thick of the crisis. Target date funds are doing their job well.
Diversification and Returns
The purpose of a target date fund is to automatically put retirement plan participants into a “healthy” diversification of stocks and bonds according to their age. The simple power of asset allocation cannot be overstated. Let’s take for example two hypothetical retirement savers, Jim and Joe. Jim is 25 and has invested 100% of his 401(k) account in ABC Company’s 2060 Target Date Fund which has a stock to bond/cash ratio of 90/10. Joe is 60 and has invested 100% of his 401(k) account in ABC Company’s 2025 Target Date Fund which has a stock to bond/cash ratio of 50/50. Jim’s account would be down by about 20% year-to-date, and Joe’s down 13%. That’s a big difference.
Said more simply by a participant who was re-enrolled into a target date fund last year and planning to retire this year: “Thank you. You saved me ton of money.”
Sticking to a Plan
With the minimized volatility and the do-it-for-me management, target date funds tend to keep retirement plan participants invested through market gyrations. We haven’t fully analyzed fund flows data from March, but we are hearing anecdotally from target date fund managers that the money in their funds is mostly staying put. There is likely more financial pain to come from this crisis, but, so far, most target date fund investors are staying the course rather than selling out of the market at low prices. There is an underlying psychological advantage knowing that whatever happens to investment markets, one’s portfolio remains in a broadly healthy allocation of asset classes.
Management and Efficiency
We are tracking commentary and feedback from target date portfolio management teams. First, these highly qualified and experienced teams are constantly monitoring portfolios. They are watching for anomalies and ensuring liquidity. Because the portfolios are wrapped into single investment vehicles, the teams can monitor and manage risk from a big picture down to an individual security level. Additionally, they have sophisticated business continuity plans that allow them to maintain effective management over the funds.
This constant oversight also makes target funds very efficient. During the quick and extreme market swings, many of the management teams are constantly rebalancing within the funds to keep the underlying goals of the investment consistent for the investor. These steps are important for investors. When equity markets collapse by 20% in a 90/10 stock to bond/cash portfolio, the portfolio manager will be buying equities and selling bonds, to get the balance back to 90/10. Buying equities at depressed prices is a good thing, as it lowers the cost basis of the investment and gives you a higher relative return on those shares. Beyond the rebalancing, some managers are also taking advantage of favorable pricing to boost returns.
If your retirement plan has high target date fund usage, take comfort in that. We have worked hard to ensure the target date fund offered in our clients’ investment line-ups are the right fit for their specific population. If your retirement plan doesn’t have high utilization of these funds or you don’t know if they’re a good fit for your employees, we’re happy to discuss options.