How might inflation affect target date funds?

There’s a lot of talk about inflation. How could it affect retirement savings?

What’s happening with inflation?

The economic slowdown caused by Covid-19 led to aggressive policy intervention, with large-scale response from government and central banks driving a rapid and robust economic recovery through stimulus checks and other policies.

However, many investors are concerned about the impact that these actions may have. Compounded with global supply chains lagging behind surging consumer demand and impacts from unrest in Ukraine, concerns about inflation are heightened.

Recent upticks

Short-term realized inflation spiked, with March 2022 seeing a 8.5% increase in CPI-U (a common inflation measure) the highest year-over-year reading in over a decade. Forward-looking forecasts are similarly high: the 10-year breakeven inflation rate, a market-based measure of expected inflation, reached a record high of 3.02% in April 2022.

As vaccine rollouts reach later stages in major economies and consumer activity returns to pre-pandemic levels, the Federal Reserve has maintained its commitment to let inflation run above its traditional 2% target.

That raises a question: is today’s accelerating inflation reflective of a short-term phenomenon, or a more permanent structural shift? And how would that affect target date funds, such as BlackRock’s LifePath®?

LifePath and inflation

Our 2019 research showed that most asset classes overcome inflation shocks given a sufficiently long investment horizon. This suggests that young investors, with long time horizons and decades of future wage growth, have less need for explicit inflation-hedging asset classes.

Conversely, investors approaching retirement have larger balances, less inflation sensitivity in their wages, and shorter time horizons until retirement. As older investors see a shift in wealth from future wages to financial assets their allocation to inflation-hedging assets should increase. The importance of inflation-hedging assets is highest for retirees who have no more wages and will begin spending from their savings, which are directly affected by inflation.

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