Is Your Target-Date Fund Providing Enough Inflation Protection?

Inflation has been on the rise recently, raising concerns about long-run inflation and its impact on the spending power of those who can least afford it—investors approaching or already in retirement. Target-date funds, owned by many defined contribution (DC) plan participants, are designed to simplify investment decisions and reduce principal risk as investors edge toward retirement.

But will target-date funds really help participants retain their spending power in inflationary times? There are strategies to help retirement portfolios guard against inflation, and they’re more critical today than ever before—but with inflation dormant for so many years, not every target-date fund is similarly equipped to be an inflation fighter.

Is Inflation Really a Threat? A Closer Look

It’s been years since investors have needed to incorporate inflation in their investment plans. But as the global economy climbs its way out of the pandemic-induced recession, the demand for goods and services is increasing faster than supply. Prices are rising, and inflation is real—particularly in the US.

Today’s inflation spike is transitory, in our opinion: supply and demand will eventually come into balance as supply chains are unkinked. But, over the longer-term, structural factors and policy regimes may push inflation higher than it’s been in recent experience.

Investors nearing retirement today were children or young adults the last time inflation was a major concern. While we don’t believe this bout of inflation will be anything like the 1970s, that era does provide a good illustration of inflation’s pain. Between 1972 and 1982, inflation averaged 9%, inflicting a 30% inflation-adjusted loss on a classic 60/40 portfolio. What if an investor was retired and also spending 4% of portfolio assets per year during this time? The portfolio value in real terms would have dropped by 65% (Display).

The returns of a 60/40 portfolio during three inflationary periods. In 1970s, the return was -65% after 4% spending.

Of course, inflation doesn’t have to be 1970s-style to jeopardize a retirement plan. Inflation spikes might not often happen, but they can be particularly detrimental for retirees who are drawing on their assets. In the short run, pent-up consumer demand, combined with supply friction, should keep inflation higher than normal. Even as supply lines are restored, fiscal and monetary policy will continue to flow into the real economy.