Lowering Equity Allocations Within Target Date Funds Would Protect Retirees’ Assets More Effectively
Welcome to the club. Along with Craig Israelsen and Moshe Molevski, I’ve been warning investors about sequence risk for years.
Target date funds embody the problem: As the Putnam paper points out, the average target date fund features an equity allocation of 45%. Yet for a portfolio designed to minimize depletion risk and sustain withdrawals, equities should make up between 5% and 25%, Putnam researchers found.
Of course, some retirees are willing to take on more risk in order to make up for savings shortfalls, and that’s a major reason for inflated equity allocations within target date funds. But they can use other investment vehicles to boost returns: The whole point of target date funds should be to protect assets against sequence and longevity risk. Importantly, most participants in target date funds withdraw their accounts at retirement, so the objective of serving to death does not square with participant behavior.
The promise of target date funds was to protect the purchasing power of accumulated distributions. Therefore these funds should stick to the accumulation phase, rather than ending up with high equity allocations at the end of the glide path period. A glide path should offer a reasonable likelihood of achieving specific objectives, not arbitrary decreases in equity allocation through time.
Advisors should begin demanding target date funds that fulfill their original promise. There is no need to passively accept the current model available for target date funds.
For more on how target date funds are missing the mark, see “The Sad Comedy of Target Date Funds.”