Target Date Funds Are Not A Set-It-And-Forget-It Proposition
Some purveyors of target date funds have argued for asset allocation patterns called “glidepaths” that are designed to serve the client through each of the three investment stages – accumulation, transition and retirement. But this type of “lifetime allocation” plan can be a mistake because investors have different needs between accumulation and distribution.
The goal is to get through the accumulation phase with the investor’s savings intact and with reasonable growth. Then at entry into retirement, each investor should carefully plan how to best use those assets for the remainder of their lifetime. That decision could not have been made earlier because it’s only at this point in the process that the advisor and investor have enough information to design the retirement phase. Only now will it become clear how much savings are available, how much debt remains, what is the health status of the investor and his or her family, what other financial obligations exist, and many other issues.
Some retirees may opt for a very conservative retirement phase plan while others may be forced to choose a more aggressive plan. Those with ample savings, for instance, can afford a conservative path while those with fewer assets will need to make some trade-offs between risk and return.
Here is proof of the criticality of the transition period: Our research shows that an individual saving $2,000 per year over the last 39 years ($78,000) would have $800,000 today, but if we run the return series in reverse, but starting in 2008, this same participant enters retirement with $1.2 million, or 50% more. This difference is due to the timing of the 2008 loss; early matters much less than later.
Note that if there were no cash flows, other than some initial account value, the ending account balances would be identical; that’s just a mathematical fact. Note also that the average annualized return during this 39-year period was 9.3%, which may or may not look like the next 39 years.
A person who retired in 1970 with $500,000 has seen his nominal account balances grow almost tenfold over the past 39 years despite 2008’s loss. But if we run the return stream backwards, starting with the 2008 loss, this same individual went broke eight years ago. The transition from the accumulation phase to the distribution phase is a particularly sensitive 10-year period: five years before transition to five years after transition. The design of most target date funds do not properly account for this critical period. The year 2008 is all the evidence we need.
For a more comprehensive look at target date funds, go to http://www.targetdatesolutions.com. For a fuller version of this article, click here.
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