If you contribute to a target date
fund in your 401(k) plan, you probably have a sense of how it works. The fund's
balance between stocks and bonds automatically shifts as you age, with less
weight on equities as you get close to retirement.
But it's
important to read the fine print on these funds, because their allocations
aren't all alike on the "target date" - the day you retire. Some
firms that manage target date funds (TDFs) adhere to a "to" glidepath
- meaning the funds reach their most conservative allocation on the target
date. But the industry's biggest players use a "through" glidepath,
meaning that the most conservative position is reached well after retirement.
The
difference is important. The "to" glidepath provides greater protection
against losses in a market downturn, but the "through" glidepath
boosts the odds of stretching your nest egg longer into retirement.
Understanding that difference will matter to a growing number of retirement
investors in the years ahead. The popularity of TDFs is soaring, with $618
billion invested at the end of 2013, according to the Investment Company
Institute - up from $160 billion in 2008.
Glidepath
design is a topic of ongoing debate in the fund industry. The latest flareup
came when BlackRock, the giant asset management firm and a key proponent of
"to" glidepaths, published a paper earlier this month making the case
for its approach. The argument rests on the notion that your "human
capital" - that is, your ability to earn income - is exhausted on your
target date, so there is no reason to be taking more market risk on that date
than later in retirement.
"The
day that you retire is the riskiest day of your life," says Chip Castille,
head of BlackRock's U.S. retirement group. "You're no longer earning, and
it's the point when you still have the longest investment horizon and your
account balance is likely to be at its highest point, which means any loss you
have will be applied to a greater asset base."
Note that
this argument isn't about your allocation to stocks and bonds, but how it
changes over time. "We aren't saying what your level of equities in retirement
should be," Castille says. "If you think stocks will give you high
return at low risk, hold a lot of them. But there's no reason to keep gliding
past the date of your retirement."
Advocates of
"through" glidepaths focus on longevity risk - the danger of
exhausting resources in retirement. That's a looming issue for a growing number
of households, since fewer retirees will be able to rely on guaranteed lifetime
income from defined-benefit pensions in the years ahead. The value of Social
Security payments also is projected to fall in the coming decades, the result
of reforms enacted in 1983.
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for the full column in Reuters.