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Will Your Target-Date Fund Work Longer Than You Will?

Some funds keep shifting their asset allocations long after the target retirement date.

How are you going to spend your 401(k) savings?

That's what the target-date industry is trying to correctly anticipate. Some firms believe investors are likely to move--or immediately spend--their savings at retirement, so their target-date funds level out at a conservative asset allocation leading into the retirement year. Others think investors are going to remain invested, so these target-date funds' asset allocations continue to evolve for years after the retirement date.

Most recently, the issue of whether target-date funds should go "to" retirement or "through" retirement has been revived in a report released by the U.S. Government Accountability Office at the request of Senator Herb Kohl's Special Committee on Aging. One of the key recommendations of that report is the GAO's suggestion that the Department of Labor require plan sponsors to consider the suitability of a target-date series' asset allocation when choosing a provider because of the great variability among the asset-allocation glide paths.

A good portion of the differences in asset allocation can be traced to the target-date series' end goal--whether it's going "to" or "through" retirement. We wanted to take a closer look at how the industry's glide paths are actually constructed according to these labels. Morningstar collects target-date funds' intended glide paths as detailed in the funds' prospectuses, and for the purposes of this study, we divided them up based on whether the funds' allocations shifted after the target date or not. This straightforward approach matches the intuitive meaning of "to" versus "through" glide paths. We found that, while certain broad generalizations do differentiate the two groups, there is also a great deal of variability within each group and more than a few cases are difficult to place altogether.

No Consensus Yet
The first thing to point out is that there is no asset-allocation consensus in the industry. Of the 41 glide paths we examined, 22 fell into the "through" grouping, with the remaining 19 landing in the "to" camp. Even though the "through" numbers have an edge and several firms, such as John Hancock and Vantagepoint, have extended the phase during which they reduce the funds' equity exposure, there's no evidence that such glide paths dominate the industry.

Some Agreement, Greater Divergence
The "to" and "through" samples look very similar, however, when investors are in their early earning years. For target-dates 2050 through 2040 (intended for investors ages 20 to 35), the average equity allocations are nearly identical, roughly around 90%.

It's when investors get closer to retirement that the differences start to show up, as "to" series move more rapidly toward the lower final equity point. The 2020 funds show a 14-percentage-point difference in equity allocation, for instance, and that difference grows to 16 points by the retirement date. At retirement, the "through" funds average a 49% stock allocation while "to" funds land at 33%. It's not until 10 years later that the glide paths meet up again as "through" glide paths hit an average allocation of 33%. Some "through" funds go lower in stocks over another five to 15 years.

So, it's in that 20-year band around the retirement date that the differences are most stark. Clearly, "through" glide paths carry higher equity risk, fitting the belief that the risk of retirees' outliving their nest eggs requires more stock investments, over longer periods, in order to raise the probability of those assets lasting through retirement. "To" paths, as advertised, cut down equity to a more manageable level by retirement, reducing the risk that investors' assets will experience a catastrophic decline just prior to their time of need.


Devilish Details
The averages seem to show that target-date series are behaving as their asset allocation would suggest, but averages also have a way of masking aberrations.

When we dug deeper into the data, we found a number of exceptions and contradictions that complicate the story.

Look first at the minimum and maximum equity allocations for the "to" and "through" paths. The wide ranges expressed there--25% to 67% for the latter, 24% to 50% for the former--suggest that there are notable philosophical differences within the broad brushstrokes of the labels. AllianceBernstein and Goldman Sachs, with stock targets in the high 60s for 2010 funds, clearly have more-aggressive assumptions than, say, Schwab, which devotes only 40% of assets to stocks at the same stage.

 2010 Allocations by Glide Path  Landing Point Allocations   AverageMinMaxAverageMinMaxThrough Funds502567332450To Funds291540NANANASource: Morningstar.  

More pointedly, some fund series are blatantly misplaced using this method. The most glaring example is the Wells Fargo DJ Advantage series, which shows up in the "through" sample despite a 25% allocation to stocks for its 2010 fund. Wells Fargo is known for having one of the industry's most conservative target-date philosophies, so why did it end up in the "through" group? Because its stated glide path extends beyond retirement, dropping equities to an extremely cautious 15% five years later. One could argue that we were overly literal in assigning Wells Fargo to the "through" group, and that would be correct. But this approach tests the results should investors interpret a series' philosophy by the trajectory of its glide path. Clearly, that approach is far from foolproof.

On the flip side, BlackRock Lifecycle Prepared funds target 50% of assets in stocks at the retirement date, on par with the typical "through" fund. Investors might assume that because the glide path levels out at the retirement date, the funds pull back on risk sharply at retirement. But by most measures, a 50/50 stock/bond mix still carries potential for a fair amount of volatility. Even though the prospectus states that assets may be merged into an income fund with board approval, the stated target allocation of the equity-income fund is 50/50 as well.

Indeed, the role of retirement-income funds, or the management of assets in the terminal fund of a series, further muddies the waters around this topic. We discerned no pattern as to whether a series used a retirement-income fund or not. One might imagine that "to" paths don't require a retirement-income fund because the glide path is not supposed to shift. That said, 14 of the 19 glide paths do. And seven of the 22 "through" glide paths lacked a retirement-income fund; John Hancock, for example, liquidated its income fund even though the firm extended its glide path, preferring to manage the allocations within the terminal fund. In some cases, the glide-path illustration as detailed in the fund prospectus did not accurately describe further changes within the income fund, which were explained in separate text.

Transparency Still Wanting
Our analysis indicates that while the terms "to" and "through" have some usefulness, it's limited. In broad brushstrokes they capture the differing intentions of firms that believe target-date funds should primarily attack longevity risk versus those that build defenses against market risks near retirement. But many series can't be labeled accurately based on the appearance of their glide paths.

Moreover, who's to say what an appropriate level of equity risk is? Russell Investments has argued that 32% is the highest level of equities appropriate at retirement to assure protection of capital. But other firms, using different assumptions, models, and goals, can argue for other levels, and it's hard to imagine the industry ever reaching a consensus. By Russell's definition, few target-date series actually qualify as "to" glide paths.

Finally, the use of equities as a guideline for portfolio risk is at best a blunt instrument. Is a bond portfolio heavily composed of high-yield bonds the same as a high-quality, benchmark-focused one? How would one account for the risk of series that invest heavily in commodities, such as those of PIMCO and Invesco, or that may have large tactical or hedging components?

Investors should view the "to versus through" facet of a target-date series as merely a starting point. To understand a series' true risk profile--throughout the entire glide path--requires a much deeper dive into its holdings and investment process. Recent regulatory proposals for better disclosure are a step in the right direction, but they're only baby steps. We're hopeful that some fund companies will continue to take the lead on providing fuller, more useful descriptions of how their target-date series are designed. In the meantime, prospective investors may need to do a lot of digging on their own.


"To" Glide Paths "Through" Glide PathsAllianz Global Investors Solutions AllianceBernstein Retirement StratAmerican Century LIVESTRONG Riversource Retirement PlusAmerican Funds Trgt Date Rtrmt Fidelity Advisor FreedomBlackRock LifePath Fidelity FreedomBlackRock Lifecycle Prepared Goldman Sachs Retirement StrDWS LifeCompass Guidestone Funds MyDestinationFranklin Templeton Retirement Harbor Target RetirementHartford Target Retirement John Hancock LifecycleING Index Solution Legg Mason Partners Target RetirementING Solution MainStay RetirementInvesco Balanced-Risk Retirement Manning & Napier TargetJPMorgan SmartRetirement MassMutual Destination RetirementMFS Lifetime Maxim LifetimeAmerican Ind NestEgg Dow Jones Nationwide Target DestinationPIMCO RealRetirement Oppenheimer LifeCyclePutnam RetirementReady Principal LifeTimeRussell LifePoints Target Date Schwab TargetState Farm Lifepath T. Rowe Price RetirementUSAA Target Retirement TIAA-CREF Lifecycle  Vanguard Target Retirement  Vantagepoint Milestone  Wells Fargo Advantage DJ Target DateSource: Morningstar. 

To see the individual Target-Date Fund Series Rating and Research Reports, click here.