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.

TDF principles

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

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.

Wrong assumption

TDF 1.0, a first-generation approach, is suboptimal. It uses a fixed glide path that assumes market volatility stays pretty much constant. Witnesses of market meltdowns in 1987, 2000 and 2008 know this assumption is wrong. Furthermore, TDF 1.0 lacks the flexibility to accommodate personal risk preferences or actual cumulative investment results. Nevertheless, RRs need to offer something at least as competitive.

Disciplined asset mix shifts are one aspect of TDFs that beat most RR-based models and wrap accounts that have naive buy-hold-rebalance strategies. Cost is a key driver for portfolio construction.

TDF 1.0 for smaller portfolios

Simplicity is the key for these investors. Ioulia Tretiakova, director of Quantitative Strategies at PUR Investing, rightly points out that “getting the broadest diversification for the money should be a primary goal.

“Investors and advisors who lack the tools to maintain consistent volatility in their portfolios (a feature of TDF 3.0) could use, as a core holding, Claymore’s Balanced Growth Core Portfolio (CBN), which includes BRIC (Brazil/Russia/India/China) and gold exposure with a 17.4% fixed income weight,” she says. “The iShares Growth Core Portfolio Builder (XGR) offers better diversification at a lower fee (0.60% vs. 0.82% for CBN) but with 60% equities and 40% bonds, it’s too conservative for long-dated TDFs.”

Some investors retire when markets are weak. It’s prudent to cash-match needs five years before funds are needed – to pay for college, for example. Zero-coupon bonds are ideal, but availability can be an issue. BMO’s Corporate Bond Target Maturity series helps. Adding these ETFs both pre- and post-retirement is a good way to preserve capital and match cash needs. Income ETFs can be added post-retirement to generate regularly distributed cash.

Next we will consider more sophisticated portfolios that incorporate inflation protection, and suggest ways to control volatility and adjust for actual investment returns.