Turning off auto pilot: Why there is more to retirement planning than the “glide-path”

There are a number of valid reasons behind the rapid growth in the use of target date funds in defined contribution plans. However, we believe the typical asset allocation approach used by target-date funds falls short of delivering the best possible retirement outcomes for investors by not reacting to market conditions dynamically.

The use of target-date funds within the defined contribution (DC) market continues to click along. The funds now account for roughly 30% of the $5.7 Trillion in 401k assets.1 Their near uniform selection as the QDIA2 means target date funds, for many younger participants, represent their sole retirement savings investment vehicle.

Target date funds have many redeeming properties, and their initial adoption by plan sponsors represented a good fiduciary decision, if for no other reason than to protect participants from themselves. Plan participants managing their own asset allocations rarely rebalance and seldom make investment decisions based upon prudent risk management.

Participants benefit from target date funds’ simplicity. Knowing when you turn 65 is a lot easier than deciding whether you have a “conservative” or “moderate” risk tolerance – something that is required by target risk funds (which incidentally have lost the QDIA foot race to target date). Target dates offer greater diversification than the prior generation of “60/40” balanced funds, and fundamentally, it is reasonable and prudent to use a strategy which moves into lower volatility assets over time.

Having said all that, the investor and sponsor concentration in target dates, and the benign environment in which they have thrived, mask some shortcomings of the design. These portfolios are not dynamic in their asset allocation. We believe that incorporating a dynamic approach to asset allocation can enhance the target date proposition and generate better risk adjusted outcomes for plan participants. In making what is, in our view, the most important decision for a fiduciary, assessing all the available options is crucial.

1 Sources: ICI.org & Morningstar
2 Qualified default investment alternative (QDIA) – The US department of Labor states that 401(k) assets “must be invested in a “qualified default investment alternative” (QDIA) as defined in the regulation” signed into law in 2006.

The views and opinions contained herein are those of Schroders’ investment teams and/or Economics Group, and do not necessarily represent Schroder Investment Management North America Inc.’s house views. These views are subject to change. This information is intended to be for information purposes only and it is not intended as promotional material in any respect.