Re-Thinking Target Date Funds
Buck Insightful Thinking, August 2011
7 Pages Posted: 4 Aug 2011
Date Written: August 4, 2011
There is growing consensus that Target Date Funds (TDFs) represent a "better" solution for retirement investing than traditional strategic portfolios like a 60/40 equities/bonds. While much marketing material hints at the fact that TDFs may provide a "safer" or "less risky" solution for retirement investing, these claims appear to have been contradicted by recent empirical evidence during the 2008 market downturn.
In this article we examine the conceptual design behind Target Date Funds (TDFs) in the context of a rigorous modern finance theory framework. In particular, we analyze the risk/return properties of the "glide path", a defining feature of TDFs, and compare them against the various claims singling TDFs out as “the” ideal solution for defined contribution retirement plans. Not surprisingly, it can be formally demonstrated that the deterministic (time based) design of "glide paths" does not necessarily improve the risk/return characteristics of retirement portfolios, and that TDFs are a riskier form of investment than commonly believed.
We make the case for a complete and consistent framework to vet the risk-and-return proposition of TDFs. In particular, financial operators and regulators should re-examine the existing TDF solutions and encourage more accurate disclosure of the expected risks and returns of each product in a manner consistent with (a) rigorous analysis based on commonly accepted financial theory and (b) realistic empirical market evidence.
Keywords: Target Date Funds, Asset Allocation, Retirement Investing, Portfolio Theory
JEL Classification: G10, G11, G23
Suggested Citation: Suggested Citation