3 reasons glide path design matters in target date funds

February 8, 2023
Time to read: Minutes

Target date funds should be designed not just to maximize wealth accumulation during a participant’s career; they should also protect that wealth as the participant approaches and enters retirement. Here are three reasons why the glide path design of target date funds matters.

1. Participants are most vulnerable on the day they retire

On the last day of a participant’s working life, their contributions to their plan end and (in many cases) withdrawals begin. Retirees face a lengthy period of covering expenses without earning a paycheck. In our view, avoiding large drawdowns in the early phase of retirement is critical to the longevity of assets. A target date fund that reduces its allocation to equities as retirement approaches can help mitigate downside risk.

2. Higher allocations to equities don’t necessarily alleviate longevity risk

Loss aversion — a powerful cognitive bias — leads most people to feel losses much more acutely than they feel gains. Put another way, the average person feels twice as much pain losing $100 than they feel joy in gaining the same amount. For retirees, loss hurts even more: according to research, a retired participant is five times more sensitive to the pain of loss than one who is still working.¹

Target date funds that have high equity allocations near (and at) retirement may force participants to bet against large market drawdowns in retirement — a bet that many older participants may not be willing to take.

3. Broad exposure to a variety of asset classes helps to manage volatility

In our view, the approach to portfolio management in target date funds should go beyond determining the optimal equity/bond allocations over a participant’s life cycle. We believe that the selection of sub-asset classes in the funds is equally important.

Accordingly, defined contribution plan sponsors should have a thorough understanding of the breadth of sub-asset classes in a target date fund — and how the sub-asset classes are adjusted to manage the various risks that participants face. We believe that target date funds that offer broad exposure to a diverse set of asset and sub-asset classes should offer more consistent investment outcomes for participants.

Tags:

Education Defined Contribution

2710100

^{1 Source: AARP and American Council of Life Insurers (ACLI). 2007. “What Now? How Retirees Manage Money to Make It Last Through Retirement.”}

Past performance does not guarantee future results. This market insight has been prepared by Voya Investment Management for informational purposes. Nothing contained herein should be construed as (i) an offer to sell or solicitation of an offer to buy any security or (ii) a recommendation as to the advisability of investing in, purchasing or selling any security. Any opinions expressed herein reflect our judgment and are subject to change. Certain of the statements contained herein are statements of future expectations and other forward-looking statements that are based on management’s current views and assumptions and involve known and unknown risks and uncertainties that could cause actual results, performance or events to differ materially from those expressed or implied in such statements. Actual results, performance or events may differ materially from those in such statements due to, without limitation, (1) general economic conditions, (2) performance of financial markets, (3) interest rate levels, (4) increasing levels of loan defaults, (5) changes in laws and regulations and (6) changes in the policies of governments and/or regulatory authorities. The opinions, views and information expressed in this commentary regarding holdings are subject to change without notice. The information provided regarding holdings is not a recommendation to buy or sell any security. Fund holdings are fluid and are subject to daily change based on market conditions and other factors.

There is no guarantee that any investment option will achieve its stated objective. Principal value fluctuates and there is no guarantee of value at any time, including the target date. The "target date" is the approximate date when you plan to start withdrawing your money. When your target date is reached, you may have more or less than the original amount invested. For each target date Portfolio, until the day prior to its Target Date, the Portfolio will seek to provide total returns consistent with an asset allocation targeted for an investor who is retiring in approximately each Portfolio's designation Target Year. Prior to choosing a Target Date Portfolio, investors are strongly encouraged to review and understand the Portfolio's objectives and its composition of stocks and bonds, and how the asset allocation will change over time as the target date nears. No two investors are alike and one should not assume that just because they intend to retire in the year corresponding to the Target Date that that specific Portfolio is appropriate and suitable to their risk tolerance. It is recommended that an investor consider carefully the possibility of capital loss in each of the target date Portfolios, the likelihood and magnitude of which will be dependent upon the Portfolio's asset allocation.

Stocks are more volatile than bonds, and portfolios with a higher concentration of stocks are more likely to experience greater fluctuations in value than portfolios with a higher concentration in bonds. Foreign stocks and small and mid-cap stocks may be more volatile than large-cap stocks. Investing in bonds also entails credit risk and interest rate risk. Generally, investors with longer timeframes can consider assuming more risk in their investment portfolio. Using diversification or asset allocation as part of an investment strategy neither assures nor guarantees better performance and cannot protect against loss in declining markets.