The words “To” and “Through” as they relate to target-date funds were coined at the June 18, 2009, Hearing on Target Date Funds and Similar Investment Options to mean:
• Through: Target date is a speed bump in the highway of life, so risk is not at its lowest point at the target retirement date.
• To: Target date is the end of the investment mission. Accumulation only, so there is no “beyond the target date” — the lowest risk is at the target date.
Subsequently, Department of Labor Target-Date Fund “Tips” for Plan Fiduciaries recommends that fiduciaries decide which type they prefer.
The common belief is that “To” funds defend better at the target date than “Through”, but this is incorrect because some “Through” funds are in fact safer than some “To” funds as shown in the following schematic:
The following chart shows which “To” funds (in red) are riskier than some “Through” funds (in blue).
A more meaningful distinction
A simpler and more straightforward distinction is between safe or risky at the target date. This is simpler because TDFs can be grouped this way; there are just two such groups. And it’s more straightforward because it directly addresses the intent to be safe or aggressive.
The TDF industry has split into two factions. One faction, anchored by the Federal Thrift Savings Plan (TSP), believes that beneficiary savings need to be protected near the target date, with no more than 30% in risky assets. This allocation is in line with surveys of beneficiaries and advisers by PIMCO and Mass Mutual. The TSP is joined by the Office Professional Employees International Union (OPEIU) and the SMART Target Date Fund Index.
The other faction, anchored by the Big 3 TDF providers — Vanguard, Fidelity, and T. Rowe Price — believes that significant risk is necessary to compensate for inadequate savings. Many currently argue that long-term bonds no longer provide protection, so this Big3 faction is 90% in risky assets at the target date — 55% equities plus 35% long-term bonds.
The glidepaths of these two factions are shown in the next graph:
Choosing between the two options
The procedurally prudent choice is the Big 3 because they have most of the $3 trillion in TDF assets, but it can be argued that substantive prudence requires safety for these six reasons.
- There’s a “baton pass” at retirement from the 401(k) plan to either an annuity or an individual retirement account (IRA) since most beneficiaries withdraw their account at retirement. Investment losses drop this baton and reduce the standard of living throughout the rest of life.
- There is a well-documented “Risk Zone” spanning the 5-10 years before and after retirement when investment losses can irreversibly spoil the rest of life.
- DOL tips advise selecting TDFs to match workforce demographics. The only demographic that all defaulted beneficiaries have in common is financial illiteracy. These naive beneficiaries need protection.
- We have a retirement crisis characterized by woefully inadequate savings. The Big 3 group aims to mitigate this crisis, but this SEC Report warns against increasing risk because it could worsen the problem, and recommends education instead that heightens awareness of the importance of saving: Save and Protect.
- 78 million baby boomers will spend much of this decade in the Risk Zone as discussed in Baby Boomer Investing in the Perilous Decade of the 2020s. They were not in the Risk Zone in 2008. There is $3 trillion at stake today versus $200 billion in 2008.
- There have been decades like the 1910s and 1970s when all asset classes had negative real returns. There is precedent, plus this current decade is not likely to be a repeat of the previous decade.
Conclusion
Safe or aggressive are more meaningful choices than “To” or “Through” when selecting a TDF. And this choice is simplified by having two distinct factions.
Ron Surz is CEO of Target Date Solutions (TDS), co-host of the Baby Boomer Investing Show (BBIS), and author of the book "Baby Boomer Investing in the Perilous Decade of the 2020s." TDS licenses target-date fund usage of Ron’s patented Safe Landing Glide Path® (SLGP) that actually protects beneficiaries as they approach retirement. Individual investors can follow the SLGP at Age Sage, an educational interactive website. The BBIS educates baby boomers on the risks and rewards in contemporary investing, and Ron’s book is a tour of these shows. He can be reached at Ron@TargetDateSolutions.com.
Great article, Ron! CAVEAT VENDOR – advisors should prepare for a pushback from their plan sponsor clients when we have a correction in the market. Even a 10-15% pullback in the market will cause harm to participants who are in their risk zone (5-10 years before and after the target date). RIA firms – if your sponsor clients are in one of the “big three” TDFs, the sponsor’s participants, who are in the risk zone, are exposed to 80-90% risky assets. As fiduciaries, our duty is solely for the best interest of participants. 90% exposure in the risk zone is imprudent and unacceptable!!