Target date fund glidepaths are a complex topic, and one that 401(k) plan advisors and plan sponsors need to have a solid grasp of to enhance the opportunity for favorable retirement plan participant outcomes.
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Boston-based MFS Investment Management recently released a White Paper focused on how fixed income should evolve across a TDF glidepath, exploring both the absolute level of the fixed income allocation and its composition in terms of fixed income sub-asset classes.
The White Paper, Revisiting the Role of Fixed Income Along the Retirement Savings Journey, shines a spotlight on the fixed income allocation within that glidepath.
401(k) Specialist sat down for a Q&A with Jeri Savage, Retirement Lead Strategist at MFS to learn more about why plan sponsors need to take another look at asset allocations across the plan’s target date glidepaths to ensure they align with the ultimate objectives of the retirement plan.
In her role, Savage is responsible for leading the firm’s defined contribution thought leadership, which encompasses trends, best practices and regulatory and legislative developments. That makes her the ideal person to discuss why fixed income plays a critical role in managing risk within a plan’s target date funds.
Editor’s Note: The Exhibits shown in the Q&A are from “Revisiting the Role of Fixed Income Along the Retirement Savings Journey.” Not all Exhibits from the White Paper are included in the Q&A, which is why the order does not correspond numerically.
401(k) Specialist: MFS recently released a new White Paper, “Revisiting the Role of Fixed Income Along the Retirement Savings Journey.” Can you give us a brief overview of the issue, and what is the primary message you want to get across with the White Paper?
Jeri Savage: As the title states, we are thinking about the role fixed income should play along the retirement savings journey. Within each phase of the journey—accumulation, consolidation and decumulation, there are key objectives for a participant’s fixed income allocation, which evolve as a participant ages.
We have found that there is a lot of variation among asset managers in how they allocate to fixed income across target date fund glidepaths. The primary message of the paper is to encourage plan sponsors to take another look—this time through a fixed income lens—at asset allocations across the plan’s target date glidepath to ensure it aligns with the ultimate objectives of the retirement program. We are taking the retirement savings journey from theory to practice by sharing our views on how we believe fixed income should evolve across a glidepath, exploring both the absolute level of fixed income allocation and its composition in terms of fixed income sub-asset classes.
401(k) Specialist: The White Paper encourages plan sponsors to take another look at their target date fund risk profiles—this time through a fixed income lens. Is this an issue that has largely been ignored?
Jeri Savage: When we think about target date funds, we typically think of the equity allocation and of a downward sloping glidepath, with higher equity allocations for younger participants, and lower equity allocations for older participants. To shine a spotlight on the fixed income allocation within that glidepath, we analyzed the fixed income allocations for the 25 largest target date funds to show the upward slope of a typical participant’s fixed income exposure and how it increases over time.
Our analysis shows that across the 25 largest target fund providers there is a wide range of allocations to fixed income across vintages. For example, the dedicated fixed income allocation in 2055 funds ranges from 1.1% to 19.2%, with an average allocation of 9.1%. The range is even wider for 2025 funds—between 41.7% to 79.2%, with an average of 49.4%. That is a nearly 20% difference in longer dated vintages and nearly 40% difference in near dated vintages in fixed income allocations across different providers in the marketplace today.
We encourage sponsors to consider the level of fixed income allocation and how it evolves along the glidepath when selecting and monitoring a target date fund.
401(k) Specialist: What can you tell us about “sequence of returns risk” and why is it important—especially in the later stages of the retirement journey?
Jeri Savage: Sequence of returns risk is the risk associated with the poor timing of negative investment returns materially impacting an investor’s ability to realize their investment objectives.
Why is sequencing risk most pronounced in the later stages of the retirement journey? Because as a participant nears retirement, balances are typically at their largest level after years of saving and positive investment returns. At this point, large, negative returns can result in large losses, and there is little time to recover. Once a participant enters retirement, the issue is complicated further by the end of contributions, which makes it harder to replenish savings, and the start of distributions, which may mean there are fewer assets that can benefit from a potential market rebound.
Portfolios that are broadly diversified may reduce the likelihood of a single market or market segment disproportionately impacting portfolio performance. Glidepaths that invest more aggressively early in the savings journey when time horizons are longest and focus on protection late in the journey help manage sequence risk. Lastly, a disciplined approach to rebalancing, particularly during bouts of market volatility, may help manage sequence risk by removing emotion from the equation, maintaining the intended risk profiles, and allowing for greater participation during any subsequent market rebound.
401(k) Specialist: You encourage plan sponsors to explore incorporating fixed income strategies beyond just a core fixed income allocation—what’s the idea behind this in terms of what it can do for participants?
Jeri Savage: We believe in the broad diversification of fixed income throughout the glidepath. Accordingly, we consider six fundamental building blocks when constructing fixed income allocations along that path: Core Bonds, Global Bonds, Emerging Markets Debt, High-Yield Bonds, Short-Term Bonds and TIPS.
The goal of constructing a diversified fixed income allocation is not to replace core bonds but rather to supplement the core bond allocation, which acts as a foundation to address participant objectives. Many sponsors agree with the investment case for including exposures to fixed income strategies with higher risk and return profiles, such as emerging markets debt or high yield, but refrain from doing so on the core menu due to concerns that participants are not equipped to effectively allocate across these strategies. These concerns, however, are mitigated when the fixed income allocation is packaged within a target date fund glidepath.
While participants do not always have exposure to every building block, and the relative size of the allocation depends on the participants position along the retirement savings journey, we feel that a diversified approach to fixed income exposure provides additional levers that can be employed to meet multiple objectives.
401(k) Specialist: Some of the largest target date managers rely predominantly on core bond allocations, especially in near-dated vintages. What are some of the potential issues with this approach?
Jeri Savage: Our analysis of the fixed income allocations of the 2025 vintages of the 25 largest target date mutual fund series, found that the number of underlying fixed income strategies employed ranges from two to 13 strategies. Furthermore, 11 target date fund managers have more than half of their total fixed income exposure invested in core bond strategies.
Participants with high allocations to core bonds and limited exposure to other fixed income strategies are potentially missing out on the diversification that could be attained through broader access to fixed income building blocks. For example, exposure to short term bonds within a near dated vintage would have been beneficial to participants in 2022 when interest rates rose dramatically, resulting in significant losses in most core bond strategies.
We encourage sponsors to look at the fixed income exposure in the target date fund and determine if it is appropriately diversified.
401(k) Specialist: You’ve done some work on the impact of fixed income allocations on participant outcomes. What have you found?
Jeri Savage: That’s right. To put our theories into practice, we analyzed differing fixed income allocations on retirement outcomes by evaluating the impact of the 2022 market environment on three participants who were planning to retire at the end of 2022.
Participant X was invested in a portfolio with 60% equity, 40% core fixed income; Participant Y was invested in a portfolio with 30% equity, 70% core fixed income; and Participant Z was invested in a portfolio with 30% equity, 70% diversified fixed income. All three participants were impacted by challenging market conditions in 2022, but Participant Z’s more conservative and diversified fixed income allocation had a significant impact on outcomes, resulting in a higher ending balance and a higher hypothetical annual retirement income amount. For many retirees, every dollar counts, and even modest losses on their retirement accounts can have meaningful implications on their standard of living.
401(k) Specialist: What are we missing—any final thoughts we haven’t covered yet that plan sponsors need to be thinking about when it comes to fixed income allocations?
Jeri Savage: I think it’s worth repeating that fixed income should play a critical role in managing risk for a retirement saver. A thoughtfully constructed, diversified fixed income allocation that evolves along a glidepath can help manage risk, particularly for participants approaching retirement. Given the disparity in the marketplace and wide variety of potential outcomes for participants, we encourage sponsors to take another look at their glidepath’s fixed income allocations.
Exhibit 6 assumptions and methodology:
Analysis assumes that each participant retires on December 31, 2022 and makes first withdrawal in 2023.
The hypothetical annual retirement income derived from the account is based on a 20-year level annuity payable at the beginning of the year using a discount rate of 4%.
Endnotes:
1(From Exhibit 2) The 25 largest target date mutual fund series by assets under management, as of 31 December 2022, provided by Morningstar Direct include Vanguard Target Retirement Series, American Funds Target Date Retirement Series, Fidelity Freedom Series, T. Rowe Price Retirement Series, Fidelity Freedom Index Series, BlackRock LifePath Index, TIAA-CREF Lifecycle Index Series, TIAA-CREF Lifecycle Series, JPMorgan SmartRetirement Series, Principal LifeTime Series, Fidelity Advisor Freedom Series, State Street Target Retirement Series, JPMorgan SmartRetirement Blend Series, American Century One Choice Series, Fidelity Freedom Blend Series, Voya Index Solution Series, Mutual of America Retirement Series, JHancock Multimanager Lifetime Series, MassMutual Select TRP Retirement Series, Great-West Lifetime Series, JHancock Multi-Index Pres Series, Guidestone Funds MyDestination Series, Schwab Target Index Series, USAA Target Retirement Funds Series and MFS Lifetime Funds.
The views expressed in this report are those of MFS and are subject to change at any time.
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MFS Institutional Advisors, Inc.