But your goal as you age is not simply capital preservation, it’s replacing lost income. When you reach retirement, you will probably need to finance about 15 to 20 years of spending between you and your spouse. But if you invest in short-term bonds and stocks—TDFs have increased stock exposure for all ages in the last 10 years—you will face a lot of risk because the bonds chosen by TDFs don’t provide much inflation protection (inflation-protected bonds are a tiny part of the bond portfolio). If inflation continues to go up and interest rates rise (decreasing the value of your bond investments), you will fall even further behind.
A better strategy would be to invest the fixed-income part of your portfolio in inflation-protected longer-term bonds, where the duration matches that of your future spending needs. And, unless you have plenty of money saved, odds are you still need some stock exposure throughout your retirement to help hedge inflation and hopefully create more growth. This offers better protection from inflation and rate fluctuations. The consequences of TDFs exposing a generation of Americans to a duration mismatch is just beginning to be felt.
Americans are retiring in a high-inflation environment, with unclear guidance on how to spend their nest egg while stuck in an investment strategy that doesn’t help them preserve income. Their spending will fluctuate year-to-year as the stock market and interest rates rise and fall, and they may experience declines in living standards as they age.
The nudge revolution has arrived at its reckoning. One of its biggest victories is raising participation in retirement savings plans, which has led to a large and positive increase in stock ownership. But the problems on the fixed-income side show nudges aren’t a cure-all; they also have to provide the right defaults.
Allison Schrager is a Bloomberg Opinion columnist covering economics. A senior fellow at the Manhattan Institute, she is author of An Economist Walks Into a Brothel: And Other Unexpected Places to Understand Risk.