Target-date or lifecycle funds (TDFs) simplify investing by automatically reducing equity exposure as a target retirement date or a student’s anticipated university enrolment approaches. TDFs are the hottest segment of a rapidly growing defined-contribution (DC) pension market. Eighty percent of DC plans in the U.S. and U.K. offer TDFs, with global uptake increasing rapidly. Impressively, two-thirds of all new money in American DC plans is flowing into TDFs. In Canada, most DC plans looking to add choices have TDFs on their wish lists, according to Mercer.
Registered representatives (RRs) should pay attention. TDFs challenge the RR’s traditional role of managing asset allocation, and do it reasonably well. The appeal of TDFs is no asset-mix decisions are required. It’s no surprise investors are embracing these one-decision products in capital-accumulation plans. If product manufacturers get their act together, retail investors could learn to love them.
The principles of TDFs are:
- Broad diversification
- Reduce equity exposure to or through the targeted date
- Low cost
There are three types of TDFs: 1.0: basic; 2.0: conservative, moderate, and aggressive for each target date; and 3.0: a proprietary goals-based version that addresses what pension investors really want — a no-hassle personal solution that increases the probability of a reliable income in retirement. (See my article “Target Date Funds 3.0” on BenefitsCanada.com.)
Fixed glide path
TDF 1.0 and 2.0 feature fixed glide paths that systematically reduce equity exposure to or through a target date. Many TDFs got into trouble between 2008 and 2009 by holding too much in equities (50% to 60%) for near-dated (2010) funds, losing 25%-30% of their value within a year.