How are you going to spend your 401(k) savings?
That's what the target-date industry is trying to correctly anticipate. Some firms believe investors are likely to move--or immediately spend--their savings at retirement, so their target-date funds level out at a conservative asset allocation leading into the retirement year. Others think investors are going to remain invested, so these target-date funds' asset allocations continue to evolve for years after the retirement date.
Josh Charlson is a strategist for the fund of funds research team for Morningstar.
Most recently, the issue of whether target-date funds should go "to" retirement or "through" retirement has been revived in a report
released by the U.S. Government Accountability Office at the request of Senator Herb Kohl's Special Committee on Aging. One of the key recommendations of that report is the GAO's suggestion that the Department of Labor require plan sponsors to consider the suitability of a target-date series' asset allocation when choosing a provider because of the great variability among the asset-allocation glide paths.
A good portion of the differences in asset allocation can be traced to the target-date series' end goal--whether it's going "to" or "through" retirement. We wanted to take a closer look at how the industry's glide paths are actually constructed according to these labels. Morningstar collects target-date funds' intended glide paths as detailed in the funds' prospectuses, and for the purposes of this study, we divided them up based on whether the funds' allocations shifted after the target date or not. This straightforward approach matches the intuitive meaning of "to" versus "through" glide paths. We found that, while certain broad generalizations do differentiate the two groups, there is also a great deal of variability within each group and more than a few cases are difficult to place altogether.No Consensus Yet
The first thing to point out is that there is no asset-allocation consensus in the industry. Of the 41 glide paths we examined, 22 fell into the "through" grouping, with the remaining 19 landing in the "to" camp. Even though the "through" numbers have an edge and several firms, such as John Hancock and Vantagepoint, have extended the phase during which they reduce the funds' equity exposure, there's no evidence that such glide paths dominate the industry.Some Agreement, Greater Divergence
The "to" and "through" samples look very similar, however, when investors are in their early earning years. For target-dates 2050 through 2040 (intended for investors ages 20 to 35), the average equity allocations are nearly identical, roughly around 90%.
It's when investors get closer to retirement that the differences start to show up, as "to" series move more rapidly toward the lower final equity point. The 2020 funds show a 14-percentage-point difference in equity allocation, for instance, and that difference grows to 16 points by the retirement date. At retirement, the "through" funds average a 49% stock allocation while "to" funds land at 33%. It's not until 10 years later that the glide paths meet up again as "through" glide paths hit an average allocation of 33%. Some "through" funds go lower in stocks over another five to 15 years.
So, it's in that 20-year band around the retirement date that the differences are most stark. Clearly, "through" glide paths carry higher equity risk, fitting the belief that the risk of retirees' outliving their nest eggs requires more stock investments, over longer periods, in order to raise the probability of those assets lasting through retirement. "To" paths, as advertised, cut down equity to a more manageable level by retirement, reducing the risk that investors' assets will experience a catastrophic decline just prior to their time of need.