Target-date funds are a class of mutual fund or exchange-traded fund designed to accumulate assets to meet an investor’s needs at a future date—the “target date.” Typically, a target-date fund holds a diversified portfolio of stocks and bonds. As the fund approaches and passes the designated retirement date, it is periodically rebalanced to be less focused on accumulation and more focused on income preservation.
Popularity of Target-Date Funds
According to Morningstar Direct, during the 12-month period ending on September 30, 2021, target-date strategies captured $1.8 trillion in assets. That number is up more than 35 percent from the total in 2020 and nearly double the $1 trillion held by target-date strategies in 2016. In general, industry analysts expect growth in target-date funds to accelerate as more asset managers turn to product innovations that focus on the needs of retirees.
Specifically, asset managers will likely be looking for products that help retirement plan participants with decumulation after they have stopped earning, which is known as the spend-down phase of retirement. Given the statistics cited above for assets under management, it seems that target-date funds are here to stay. Accordingly, it’s important to look at how these strategies are built—in other words, we need to understand “What’s under the hood?”
Glide Path Strategies
When exploring the question of how a target date fund is constructed, we must look at the asset allocation strategy, which is known as the glide path. There are two different flavors of glide paths for target-date funds: “to” and “through.”
“To” glide path. A “to” glide path is designed to become increasingly conservative and risk-averse as it approaches the targeted retirement date. As investors move closer to retirement, the need to preserve wealth takes precedence over accumulation goals.
“Through” glide path. In contrast, a “through” glide path is managed throughout the plan participant’s life after retirement age. With this strategy, the fund’s allocation is meant to address accumulation needs up to a specified number of years after the date of retirement. Generally, “through” funds maintain a higher equity stake for a period of 10 to 20 years past the designated retirement age.
Variations in Asset Allocation
Another difference advisors should investigate is the asset allocation of each target-date portfolio. It’s important to understand how broadly diversified the allocation is and how the portfolio could be adjusted to market conditions during an investor’s pre- and post-retirement years. Some portfolio managers may choose to take a more tactical approach to the glide path strategy. In these cases, the managers would choose to actively shift the fund's allocation, perhaps including or excluding a given asset class based on current market conditions or expectations for future conditions.
Cost is an aspect of target-date funds that can vary significantly. As with asset allocation, whether a fund’s underlying asset classes are primarily actively managed or passively managed will have a big impact on costs. The annual cost of an actively managed fund might vary from about 37 bps to 50 bps. For a passively managed index fund, on the other hand, the annual cost might be as low as 6 bps.
Focusing on Fund Disclosures
As always, as the year comes to an end, advisors should examine whether their clients’ investments continue to meet their needs. Regarding any holdings in target-date funds, investors should look specifically at the fund’s glide path, asset allocation, and costs. To meet an investor’s retirement goals, it’s especially important that both advisors and investors are clear about a target-date fund’s objectives, as described in the fund’s disclosures.
Investments in target-date funds are subject to the risks of their underlying holdings. The year in the fund name refers to the approximate year (the target date) when an investor in the fund would retire and leave the workforce. The fund will gradually shift its emphasis from more aggressive investments to more conservative investments based on its respective target date. The performance of an investment in a target-date fund is not guaranteed at any time, including on or after the target date.