15 October 2018

Where Is Your Target Date Fund Aiming?

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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.

Click here for the full column in Reuters.

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