Navigating participants through uncertainty

Inflation is on everyone’s mind these days, and for good reason. It's hard to miss its effects on a daily basis at the grocery store, the gas pump and in many other parts of life.

The annual inflation rate surged to 8.5% in March 2022 according to the Bureau of Labor Statistics – the highest it’s been in 40 years and a steep departure from the historic 2%.

We may be living with inflation and volatility for some time, so it’s important to help participants understand adopting a long-term perspective can help them weather the uncertainty and navigate this unprecedented duality of inflation and volatility.

Investments and behavior

There are two dimensions to consider: one investment-related, the other behavioral.

From an investment standpoint, we know that, over the long term, most asset classes deliver a positive real return.¹ They outperform inflation. When it comes to target date funds, however, some do a better job diversifying a broad portfolio in periods when inflation is high, or when inflation rates exceed levels that were anticipated. Our approach to incorporating inflation-sensitive asset classes is rooted in understanding the nuanced ways that inflation can affect a portfolio in different economic regimes. Since the target date fund is largely the primary savings vehicle for most people, it’s key that plan sponsors are aware of the asset allocations in them.

At the same time, participant behavior can have a big impact on retirement outcomes. The focus on rising inflation may cause some participants to stop contributing. That might be rooted in fears that prices will continue to increase, and the purchasing power of their savings will decrease substantially. So, we should continue to educate and emphasize that how inflation and other factors can affect savings depends a lot on how people react to it. 

The right mix for inflation

Time is on the side of younger participants. Since 2000, wage growth has been higher than inflation 72% of the time and has never had a negative 12-month period.² BlackRock’s research shows that -– given enough time -- most asset classes will provide returns equal to or above the inflation rate.³ Participants should consider staying the course, if for other reason than to take advantage of potential upswings in the market.

One asset class that might not do well in an inflationary environment are traditional “nominal” bonds, since their coupons pay a fixed rate. When inflation is higher than nominal interest rates, traditional bond returns are unlikely to keep pace with the rising cost of living.

On that note, stable value funds could also be problematic, particularly with older workers, who tend to hold large positions in these conservative investments. Stable value returns are driven by the portfolio’s “crediting rate,” which is designed to “smooth” the returns that investors receive, which can result in these funds earning a stable and relatively constant rate, that is designed to protect principal. However, that smoothing mechanism may result in the crediting rate being below market interest rates which might not outpace inflation, which could reduce buying power.

In the event that inflation is persistent, it could be a challenge for investors approaching retirement who have larger balances, less inflation sensitivity in their wages, and shorter time horizons until retirement.³ It’s important for these investors to consider holding appropriate-sized allocations to investments that are more inflation-sensitive such as TIPS, Real Estate, and Commodities. They could also utilize a well-designed target date fund. Relying on conservative investments like bonds, stable value or money markets can be a risky proposition in times of persistent inflation times. 

Staying invested even through volatility

2021 was an exceptional year in the markets, so it’s reasonable to expect a return to something that seems a bit more “normal.” A normal market, however, involves some volatility, which in the short-term, can make people uncomfortable.

Even if a participant in a target date fund is not close to retirement, instincts may make them still want to scale back. It can be frustrating to see balances go down -- or their dollars buy less -- even in a long-term investment like a retirement plan.

But let’s take a closer look. The recent volatility has little to do with underlying stock market fundamentals. BlackRock believes the recent market concerns are rooted in rates and inflation.⁴ Volatility will likely persist as the Federal Reserve pulls back the stimulus policies put in place early in the pandemic.

It’s important that participants know that, historically, stock market downturns are often followed by a period of positive market performance. Since 1987, every major decline in U.S. equities has reversed itself between 21% and 68% within the following year.⁵ Research also shows that participants who keep contributing to their retirement plans have the potential to take advantage of these market recoveries. For example, those who stayed in their plan from 2007 through 2013 saw their average account balances increase by 86%.⁵

The bottom line

Despite the double concern of inflation and market volatility, participants should consider staying the course, largely so that they don’t miss out on any potential market upturns. It's another good reason why a target date fund, if constructed with sufficient downside protection and adequate inflation hedging, can be the best option for most participants. In addition to being structured with age-appropriate investments, with a long-term strategy, they can also offer built-in protections from inflation.

Learn more