By John Coumarianos
How much is enough? The 10 largest target-date 2020 funds offer some answers
Everyone is worried about how inflation will affect their investment portfolios - and even more so for retirees whose portfolios have to support distributions adjusted for inflation.
As a follow-up to my interview with financial adviser Bill Bengen last October, I used his updated 4.7% distribution rule to see how the 10 largest target-date 2020 funds would have fared, assuming a retiree used them as their primary investment vehicle from 2020 through 2023 - a full four-year period that included an inflation spike.
As a reminder, Bengen's rule says to take 4.7% of your assets in the first year and adjust that dollar amount for inflation in subsequent years. That, according to Bengen's historical simulations, gives you a good chance of not running out of money.
Target-date fund simulation
The simulation assumed a withdrawal of $9,400, or 4.7%, from a $200,000 investment in each fund in the first year of retirement (2020). The withdrawal was adjusted in subsequent years for the prior year's inflation rate. The simulation used annual inflation numbers compiled by the Minneapolis Fed.
Here are the 10 funds used in the simulation:
Vanguard Target Retirement 2020 Fund (VTWNX) American Funds 2020 Trgt Date Retire R5 (RECTX) Fidelity Freedom 2020 (FFFDX) T. Rowe Price Retirement 2020 (TRRBX) Fidelity Freedom Index 2020 Investor (FPIFX) T. Rowe Price Retirement I 2020 I (TRBRX) TIAA-CREF Lifecycle Index 2020 Instl (TLWIX) TIAA-CREF Lifecycle 2020 Retirement (TCLTX) Principal LifeTime 2020 Institutional (PLWIX) JPMorgan SmartRetirement(R) 2020 R5 (JTTIX)
To keep the math manageable, the formula accounted for a lump-sum distribution at the start of each year - though a more realistic distribution schedule for a retiree might be monthly or quarterly, with inflation adjustments also occurring incrementally.
The following numbers represent the investment value of the funds at the end of each year, accounting for both the distribution at the start of the year and each fund's performance for the year.
The good news is the 10 largest funds had an average balance of $193,000 after four years of following Bengen's rule. That's even after a U.S. stock-market decline in 2022, when the S&P 500 SPX lost around 18%, and a period during which inflation ran at 14% cumulatively, including 8% in 2022.
The best of the funds, T. Rowe Price Retirement I 2020 (TRBRX), had a $200,076 balance at the end of 2023, right before this year's distribution. The worst, JPMorgan Smart Retirement 2020 R5 JTTIX, had an end-of-year 2023 balance of $183,328.
The bad news, besides the JPMorgan fund being cause for some concern, is the funds have to support a distribution of $10,757 this year after accounting for last year's 4.1% rate of inflation.
Besides its 0.44% expense ratio being among the higher in the group, the JPMorgan fund in early 2021 had 32% equity exposure, the lowest in the group, according to a Morningstar time-series data tab that goes back three years. All the other funds had more than 45% equity exposure, with T. Rowe Price leading the way with around 55% equity exposure at that time.
The low stock exposure hurt the JPMorgan fund in 2021, a year when the S&P 500 delivered a return of more than 28%, putting the fund in the 90th percentile of the Morningstar category for the year. The fund then boosted its equity exposure to around 40% during 2022, when the market was dropping, helping it to enjoy last year's recovery somewhat. The fund finished in the top half of the category in 2022 and around the middle of the category in 2023.
Vanguard Target Retirement 2020 Fund VTWNX, by contrast, had around 47% equity exposure in early 2021, and most recently had 38.7% equity exposure, the lowest among the largest 10 funds. Equity exposure among the 10 most recently ranged from Vanguard's 39% to around 51% for both T. Rowe Price funds. The JPMorgan fund is at around 41%.
International pain
Another thing for investors to consider is that all of these funds have held healthy amounts of international stocks throughout the period under consideration - anywhere from 13% (JPMorgan) to 26% (Fidelity Freedom 2020 FFFDX) three years ago. Currently, the range is from 14.7% to 23% (for the same two funds).
Although in line with a certain prudence regarding diversification, this has hurt all the funds mightily. The S&P 500 has smashed the MSCI ACWI Ex USA Index (the world's stock markets minus the U.S.), with a 12.04% return on an annualized basis versus a mere 3.75% annualized return, for the four years through 2023.
None of this means retirees should avoid international stocks. Although there are no guarantees, it often happens that investors become thoroughly disgusted with an asset class to the point of shunning it just as that asset class is poised to outperform.
More is better
It looks like more stock exposure has been better in this simulation, and that's in accord with research that Morningstar's John Rekenthaler did recently.
Rekenthaler ran a simulation where he compared a traditional glidepath (fewer stocks the older the investor was) to a flat glidepath (the same stock exposure at all times) and then to a reverse glidepath (more stocks the older the investor was).
Rekenthaler ran the glidepaths from the savings period through the distribution period, whereas the simulation here concentrates on the distribution period. That makes the comparison awkward and imperfect, but perhaps still useful.
Each of Rekenthaler's approaches averaged 70% stock exposure over time, and Rekenthaler said he personally preferred a portfolio that held steady at 70% stocks at all times because the traditional glidepath approach proved superior in only the worst 15% of cases historically.
Still, it may not be bad for investors in the distribution phase to orient themselves around worst-case scenarios. Nobody knows if we're on the cusp of one of those worst-case periods. But U.S. stocks are in the upper reaches of their historical valuation on a Shiller PE basis (price relative to the past decade's worth of real, average earnings).
Moreover, what may be a higher interest-rate environment than we've seen in two or more decades may mean some caution is in order. A more conservative posture may yet have its day against more aggressive allocations for retirees.
John Coumarianos is the founder and managing member of Mindful Advisory, LLC in Northvale, N.J. Follow him on X @JCoumarianos.
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-John Coumarianos
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04-17-24 2017ET
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