Off-the-shelf retirement target-date funds are built using average U.S. demographic data and are designed to provide a typical investor with exposure to a well-diversified portfolio that becomes more conservative as the investor nears retirement. These target-date products are often built for specific types of investors; for example, investors who have a high-risk appetite or investors who are primarily focused on capital preservation.
One Size Doesn’t Fit All
All glide paths are not the same, and that one size does not fit all. Therefore, it follows that the shapes of individual glide paths can be vastly different across retirement target-date funds (TDF), as depicted in the graph below. Among the 60 target-date series studied in the Morningstar Target-Date Report1, there is a 30 percentage point equity allocation differential at the starting point of the target-date series. Likewise, there is a 42.5 percentage point equity difference at the termination point among the different series. Not surprisingly, there are countless glide path designs throughout the dataset studied.
Moreover, even among the top five target-date providers, we find great variation in the bond and stock mixes of the glide paths, as illustrated in the chart below. For example, there is a 16% difference in the equity allocation between the 2030 TDFs of five providers.
Characteristics are Key
Even sophisticated investment committees can struggle with selecting retirement TDFs because of the complexity of this decision and the lack of tools to assist plan sponsors. The Department of Labor even provided guidance to plan sponsors, advising that it is a “best practice” to discuss specific characteristics of their participant population with prospective target-date fund providers. These particular characteristics may include salary levels, turnovers rates, concurrent participation in a defined-benefit plan, contribution rates, and withdrawal patterns2.
Quantitative Analysis is Best
Selecting the correct glide path is one of the most important decisions that a plan sponsor or consultant can make. But the few existing methods for evaluating the risk capacity of plan participants tend to focus on qualitative factors, such as how much risk participants prefer, and provide little help to plan sponsors. We believe that it is impossible—and imprudent—to rely solely on a questionnaire to determine an appropriate glide path. The most reliable method for assessing the risk capacity of a plan is to perform a quantitative analysis of the plan’s participants, and determine the risk capacity—or appropriate equity exposure—of the participants. Leveraging this data is crucial for optimal alignment of retirement target-date funds.