Tactical Target Date Funds

Abstract

We propose target date funds modified to exploit stock return predictability driven by the variance risk premium. The portfolio rule of these tactical target date funds (TTDFs) is extremely simplified relative to the optimal one, making it easy to implement and communicate to investors. We show that saving for retirement in TTDFs generates economically large welfare gains, even after we introduce turnover restrictions and transaction costs, and after taking into account parameter uncertainty. Crucially, we show that this predictability is uncorrelated with individual household risk, confirming that households are in a prime position to exploit it.

Keywords: target date funds, life cycle portfolio choice, retirement savings, variance risk premium, strategic asset allocation, tactical asset allocation, market timing

JEL Classification: G11, D14, D15