What is a Target Date Fund and its Glide Path?
A Target Date Fund (TDF) is a mutual fund that is designed to accumulate and deliver assets on a specific event date, for example the year a person plans to retire. If that year was 2040 then a person would invest in a 2040 TDF.
When the target date is years or decades away the fund takes more risk by investing in a higher percentage of stocks and other more volatile investments that are supposed to produce higher returns. As the target date gets closer the fund gradually reduces risk exposure. This is called the glide path. Every TDF has a glide path that controls asset allocation and exposure to risk.
A glide path is also associated with the gradual landing of an airplane that decreases altitude until it is on the ground. Consequently, some people associate glide path with a safe landing for their retirement assets on their target date.
TDFs were originally used for college savings plans, where the target date was the year a child planned to start college. But, in the early 2000s, TDFs began to appear in 401(k) retirement plans. The Pension Protection Act of 2006 was the big breakthrough for TDFs because the Act established TDFs as one of three Qualified Default Investment Alternatives (QDIA). The other 2 QDIAs were balanced funds and managed accounts. By far, TDFs have become the most popular QDIA.
Companies that provide TDFs create glide paths that gradually decrease risk (altitude) as people get close to retirement. There is very little disagreement about how much risk is acceptable when the target date is more than ten years in the future. Most TDFs are heavily weighted in equities (stocks and real estate) when the target date is a decade or more away. However, there is a lot of disagreement about how much risk is prudent when people are close to retirement age, as well as currently retired, ranging from a low of 15% in stocks to a high of 70% in stocks.
These disagreements are not earthshaking when you consider three firms manage most of the assets and their glide paths are relatively similar. Vanguard, Fidelity and T Rowe Price manage 65% of the $2 trillion in TDFs, with Vanguard managing 40%. A market structure where a handful of firms control the majority of the assets is an Oligopoly.
Why do three firms dominate the TDF marketplace? The trustees of the qualified plans feel safer, from a fiduciary standpoint, when a brand name is investing their plans’ assets. We will not comment on the wisdom of this feeling.
The “Big 3” are about 55% in equities at the target date, trending down to a flat 45% in retirement. It is interesting to note, the Big 3’s 2010 TDFs lost 30% of their value in 2008, and they have increased their TDFs’ risk exposure since that stock market crash.
Innovation is difficult and it evolves over time, in particular when an oligopoly controls a market, but there are several improvements underway. TDFs have become more diversified, introducing asset classes like real estate and commodities, and fees have come down, primarily in response to successful lawsuits for excessive fees.
But the biggest improvement is in risk control. A “U-shaped” glide path is very protective at the target date, with less that 20% in equities, and then it gradually re-risks in retirement to extend the life of investments. Extensive research has led to this groundbreaking improvement.
TDF are here to stay and they will continue to evolve. Current concerns are that one-size-fits-all cannot serve the disparate needs of an entire employee population and that risk near the target date is too high.
These problems are being addressed. One very promising solution is “Target Date Portfolios” where portfolios are tailored to meet the goals and requirements of individual investors.
About the Author: Ron Surz is CEO and CIO of GlidePath Wealth Management an innovative money management firm that uses a patented investment process to invest retirement assets that are held outside qualified retirement plans. GlidePath manages Target Date, Invest-for-100, Special Situations and Recession Protection Portfolios.