Are you someone who feels anxious when the markets are unpredictable?
You may have heard about “smoothed” funds. These funds are designed to keep your investments steady, offering a way to manage market ups and downs without all the drama. But how do they work, and are they right for your retirement plan?
How Do Smoothed Funds Work?
Smoothed funds work differently from traditional investments like stocks or bonds. Instead of experiencing daily price changes based on market conditions, smoothed funds average out the price of the underlying investments over six months. This means that instead of seeing your investment value fluctuate every day, you see a more stable, smoothed price.
In good market conditions, smoothed funds might not give you all the gains upfront. They hold back some of the growth to create a reserve. This reserve acts as a buffer during bad times. When the markets dip, the fund uses this cushion to smooth out your losses. Essentially, it’s designed to give you a smoother, less stressful investment journey.
Do Smoothed Funds Work?
During the COVID pandemic, some investors discovered that smoothed funds were effective in helping them avoid significant losses compared to more traditional investment portfolios consisting of stocks and bonds.
To compare smoothed funds, let’s consider a common portfolio strategy: a mix of 60% global equities (Stocks & shares around the world) and 40% bonds, often referred to as a “balanced” portfolio. This balanced approach is widely seen as a straightforward strategy as it spreads risks between equities and bonds, which do not always move in the same direction.
Comparing Smoothed Funds to a Balanced Portfolio
During the market turbulence caused by COVID-19, smoothed funds showed some benefits compared to a traditional balanced portfolio. The balanced portfolio had a sharper drop during the worst of the pandemic, around 16%, while the smoothed funds generally had much smaller decreases, with only one of them losing more than 10%. This suggests that the smoothing mechanism effectively reduced the impact of the downturn. However, it’s important to consider that the COVID downturn was relatively short-lived. By the end of the year, the balanced portfolio was up by more than 10%, while some of the smoothed funds were barely in profit.
What happened in 2022 and 2023?
Smoothed funds did well during COVID-19, but in 2022, some struggled during market declines. For instance, one fund dropped by 11%, nearly as much as the 13% drop in the balanced portfolio. However, other smoothed funds performed better, showing that they don’t all perform the same way. When markets recovered in 2023, the performance of the “balanced portfolio “was better than all but one smoothed fund.
What About During the Global Financial Crisis?
During the 2008 Global Financial Crisis, both smoothed funds and balanced portfolios dropped by around 16 to 18%. However, the balanced portfolio recovered more quickly, making a profit by the end of 2009, while the smoothed fund was still showing a loss. Five years after the crisis began, the balanced portfolio was ahead by around 10%, and by 2018, it had outperformed the smoothed fund by 22% over ten years.
