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How Much Risk Is Your Target-Date Fund Taking?

Here's what a glide path is and why it matters.

Susan Dziubinski: Hi, I'm Susan Dziubinski with Morningstar. New research from Morningstar shows that the glide paths of target-date funds continue to shift more heavily toward equities. What does that mean for investors? Joining me to answer that question and others is Megan Pacholok. Megan is an analyst with Morningstar's Global Multi-Asset Funds Research team.

Hi, Megan. Nice to see you.

Megan Pacholok: It's great to be here. Thanks, Susan.

Dziubinski: Let's start out by defining some terms. First, what's a glide path?

Pacholok: A glide path is essentially the allocation across asset classes through a target-date fund. So, if an investor is choosing a target-date fund and investing in it 40 to 45 years from their target retirement date, that portfolio will hold a lot of stocks. As slowly you get closer and closer to that retirement date, it starts to de-risk, or add bond funds, to the portfolio. And as that equity allocation shifts down, it forms the glide path.

Dziubinski: Now, Megan there is a difference between a "through" glide path and a "to" glide path. Talk about that.

Pacholok: A "to" glide path essentially stops shifting that equity allocation once you hit the target retirement date, locking in that equity allocation, whereas a "through" glide path will continue to de-risk, or lower that equity allocation, for another 10 to 20 years past their target retirement date.

Dziubinski: Morningstar recently published its latest target-date landscape report, and in that you note that glide paths have become more aggressive over the past decade or so, meaning that they tend to have higher stock allocations. How significant has that shift been over time?

Pacholok: On average, the entire glide path shifted up a little bit, meaning that across the entirety, it has a higher stock allocation. But really, the equity allocation shot up much higher at the onset. So, in that first target-date portfolio, it went up about 7% to be 92% equities, whereas at that retirement date, it only went up about 3 percentage points to be about 43% equities.

Dziubinski: Megan, you say in the report that part of the reason for this shift has been an increase in the number of target-date strategies that have "through" glide paths. Tell us a little bit about that.

Pacholok: Target-date providers are favoring the "through" glide path. And 28 of the target-date funds that were launched over the past decade, four fifths of them were actually with that "through" glide path.

Dziubinski: Are there other reasons, though, that the target-date series tend to have more aggressive glide paths and more exposure to equities today besides that?

Pacholok: We've seen more and more fund providers as well as investors become a little bit more comfortable with the idea of having a more aggressive glide path. And that could also be in part with the fact that equities have done so well over the past decade and interest rates have been so low.

Dziubinski: Then, who are some of the more aggressive target-date providers in terms of their equity exposure?

Pacholok: Two target-date funds that Morningstar analysts rate that do have that more aggressive glide path would be T. Rowe Price Retirement and BlackRock LifePath Index. The T. Rowe Retirement Fund, that one actually shifted their allocation in 2020, and at the onset, their equity allocation is 98% in equities. If you think about it against the average, which is 92%, that is a bit of a significant jump. And in terms of BlackRock, they have an equity allocation of 99% equities in the beginning. And they actually were early adopters of that change, and they made the change in 2014.

Dziubinski: So, then, how should investors be thinking about target-date strategies and those glide paths? Is a higher equity allocation a good thing or a bad thing?

Pacholok: It really actually depends on the investor's preference. If they can stomach the volatility of holding more equities, a higher equity allocation could actually benefit them, because they do have that longevity of being able to bounce back from a market dip, and they also have a higher potential of having more gains with that higher equity exposure. But again, it really depends on if they can stick with it during the market drawdowns.

Dziubinski: Megan, thank you so much for your time today and giving us a little bit of insight into the glide paths and target-date funds and how those have changed over time. We appreciate it.

Pacholok: Thanks for having me, Susan.

Dziubinski: I'm Susan Dziubinski with Morningstar. Thanks for tuning in.