By Bob Schultze
The growth of target-date—or retirement-date-specific asset allocation—funds is undeniable. A study from the National Association of Government Defined Contribution Administrators (NAGDCA) found 64 percent of public-sector defined contribution (DC) plans had a target-date fund as the qualified default investment alternative (QDIA).1
Plan sponsors view target-date funds as a strong solution to their employees' investment goals. The MFC Defined Contribution Trends Study found in 2017 that 81 percent of plan fiduciaries were confident in the ability of target-date funds to meet the long-term needs of their participants.2
Importance of Glide Path
A key reason fiduciaries are selecting these funds as their plan's QDIA is the presence of a glide path. A glide path is the fund's asset class allocation, the balance between equity (stocks) and fixed-income investments (bonds), to balance volatility and longevity risks.
Generally, target-date funds employ an age-specific glide path, which refers to the shift from equities, a market-risk investment, to fixed income, a longevity-risk investment, as a participant prepares for and is in retirement. Early in a participant's career, the target-date fund is heavily invested in equities that are more volatile but produce higher returns over longer time frames.
As the participant approaches retirement, the target-date fund's asset allocation mix shifts to fixed income, becoming more conservative with an objective to produce income to fund the participant's retirement. The glide path is important because asset allocation is one of the most important factors to properly balance portfolio risk and return.
Two Possible Approaches
Broadly, there are two approaches to glide path construction: to date and through date. To-date glide paths end their asset allocation shift on the date stated in the fund's name, leaving the target allocation percentages the same for the remainder of the fund's life.
Through-date glide paths continue to shift the asset allocation for a set period after the retirement date. Specifically, to-date glide paths shift to fixed-income assets faster than those constructed with a through-date focus.
Each construction method has benefits and shortcomings: To-date target-date funds better protect investors against a bearish stock market and sequence of return risk while through-date funds protect against longevity risk and, in a rising equity market, allow investors more time to grow retirement assets.
In light of current trends—longer lifespans, in addition to the presence of such additional income as second careers, Social Security, and pension benefits—ICMA-RC uses a through-date construction with a 10-year post-retirement asset allocation adjustment period. We feel this will lead to more positive participant outcomes in the decades ahead.
Although the to-date versus through-date debate will continue, with both approaches having their proponents, target-date funds are helping participants better prepare for retirement in a streamlined manner with investment professionals managing the assets with an eye on age-specific risk profiles.
A Common Goal
How can plan sponsors make target-date funds available to plan participants? Most public sector plan sponsors already offer these funds through their retirement plan lineups as the QDIA. Others offer target-date funds as a means of broadening investment options for plan participants.
No matter the reason, improving participant outcomes is a common goal we share with plan sponsors as we work to help build public sector retirement security.