Target-date funds are the asset management industry’s closest thing to a one-size-fits-all product for a broad cross section of America’s retirement savers, and glide paths are the investment blueprints that the funds use to help those investors pursue their goals.
Target-date funds have become increasingly popular products for individual investors seeking to accumulate savings during their working years while managing risk during the transition to retirement. The funds emerged in the 1990s, and they took a big leap forward in 2006, when Congress allowed them to serve as default investments in 401(k) plans for automatic enrollees who don’t specify how to invest their money. By the end of 2016, target-date fund assets grew to a record $880 billion—up from $763 billion the previous year, and a nearly sixfold increase over the course of a decade.1 And target-date funds aren’t just for retirement; some are tailored to the needs of families saving for their children’s college costs.
How target-date funds work
While there are many considerations in choosing a target-date fund, the products offer appealing simplicity on a couple levels. An investor can choose a fund with a target date in its name—say, a 2030 or 2045 fund—that roughly coincides with the year of the individual’s anticipated entrance into retirement, or a child’s enrollment in college. Over the years, the fund’s manager adjusts allocations to stocks, bonds, and other assets as investor risk tolerance changes approaching the target date. The products may appear somewhat commoditized because they all have target years in their fund names, but they vary widely in how they pursue wealth accumulation and retirement security.
The heart of the fund—its glide path
Perhaps the most important distinguishing feature of any target-date fund is its glide path—the asset allocation adjustments that the fund makes to balance growth potential with risk management as an investor ages. For example, target-date funds typically keep the vast majority of assets invested in stocks during the early and middle stages of an investor’s working years, when retirement is likely to be decades away. At that point, most funds’ glide paths offer equity exposure of around 80% to 90% of the overall portfolio, with the rest typically in bonds.
The rationale for the high equity exposure? On average, stocks have historically generated stronger investment returns than bonds over multi-year periods, albeit with higher volatility. While it’s not unusual for stocks to underperform bonds or other assets for relatively short periods, equities have a historical record of outperforming over time, so they’re regarded as having greater long-term earnings potential than bonds. When equities experience market downturns, younger investors are typically in a better position to weather portfolio drawdowns than those close to or in retirement, as gains from positive equity market performance are likely to offset losses over the decades-long investing time horizon of a younger worker. For those who are in their 50s and 60s—in what’s sometimes called the “retirement readiness” zone—ill-timed market losses can be especially painful, as they can take a significant bite out of portfolios just as near-retirees face the prospect of tapping their invested savings to cover living expenses.
Glide path design is guided by the varying durations of investors’ time horizons. Retirement no longer seems so distant when an investor turns 40 or so; at that point, most glide paths begin to gradually ramp down their equity exposure. A typical glide path provides around 70% to 80% equity exposure when the target retirement date is a couple decades away, and then 50% to 65% when it’s 10 years away. At the target retirement date, most glide paths offer equity allocations of around 40% to 55%. However, a significant number of glide paths vary from these ranges, offering alternative approaches that may be more appropriate for certain investors, depending on non-age factors that may affect time horizon and risk tolerance.
To and through approaches to glide path design
Once at the target retirement date, glide paths generally take one of two approaches to address very different objectives. Most are “through” glide paths, so named because they continue to gradually ease back on equity exposure through the first 10 to 20 years of an investor’s expected retirement. Generally, through glide paths offer equity allocations around 25% to 50% during the first decade or so of retirement, and then remain static with slightly less equity exposure once the investor has been retired for a couple decades. This approach aims to address the needs of investors who may live into their 80s, 90s, and perhaps beyond. The thinking behind through funds is that an investor should stick with a consistent long-term strategy that adjusts asset allocation well into retirement, rather than remaining static. With today’s increasing life expectancies, many investors may need to maintain earnings potential from significant equity exposure to address longevity risk—the prospect that an investor might outlive his or her savings.
Another approach is the “to” glide path, which maintains a static asset allocation once an investor reaches the target retirement date, resulting in a flat line on a chart depicting a glide path. The thinking here is that the entrance to retirement is a decision point at which the investor may wish to transfer assets held in a target-date fund into other vehicles designed for retirees. In the transition to retirement, many investors move invested savings from IRAs, 401(k)s, or other workplace savings plans into a unified account managed by a financial advisor, and a target-date fund may not be deemed the best option to meet an individual’s retirement needs.
Target-date investing with college in mind
Target-date funds designed for families saving for their children’s college educations follow a similar approach to retirement-oriented funds, but in a relatively compressed timeframe—measured in no more than a decade or two—as a child matures. Often, a family may choose to place their contributions in one of several portfolios of underlying mutual funds. In most instances, the asset allocation of each portfolio corresponds with the beneficiary’s expected college enrollment date—the closer a child is to college age, the more conservative the asset mix is, with less equity exposure and more fixed income. The asset manager then adjusts the portfolio’s allocation over time. At enrollment and throughout college, allocation remains conservative to try to ensure that expenses can be covered even in the event of a significant market downturn.
1 2017 Target-Date Fund Landscape, Morningstar, Inc., 2017.
Diversification does not guarantee a profit or eliminate the risk of a loss.
A note on target date funds: The portfolio's performance depends on the advisor's skill in determining asset class allocations, the mix of underlying funds, and the performance of those underlying funds. The portfolio is subject to the same risks as the underlying funds and exchange-traded funds in which it invests: Stocks and bonds can decline due to adverse issuer, market, regulatory, or economic developments; foreign investing, especially in emerging markets, has additional risks, such as currency and market volatility and political and social instability; the securities of small companies are subject to higher volatility than those of larger, more established companies; and high-yield bonds are subject to additional risks, such as increased risk of default. Each portfolio's name refers to the approximate retirement year of the investors for whom the portfolio's asset allocation strategy is designed. The portfolios with dates further off initially allocate more aggressively to stock funds. As a portfolio approaches and passes its target date, the allocation will gradually migrate to more conservative, fixed-income funds. The principal value of each portfolio is not guaranteed, and you could lose money at any time, including at, or after, the target date. Liquidity-the extent to which a security may be sold or a derivative position closed without negatively affecting its market value, if at all-may be impaired by reduced trading volume, heightened volatility, rising interest rates, and other market conditions. Hedging and other strategic transactions may increase volatility and result in losses if not successful. Please see the portfolio's prospectus for additional risks.