Longer-Term View Needed for TDFs

Fidelity finds the wealth accumulated by a hypothetical investor at an assumed retirement age of 65 following a longer, “through-retirement” TDF glide path was greater than the wealth generated by a “to-retirement” glide path in 90% of simulated macroeconomic scenarios. Similarly, through-retirement investment programs also generated more wealth when examining most historical scenarios, Fidelity says.

The paper, “Achieving Retirement Success: Do ‘To’ or ‘Through’ Glide Paths Lead to Higher Wealth?,” reveals how the design of a target-date strategy is often determined by an investment manager’s belief as to whether a glide path should reach its most conservative allocation at a specified retirement date (i.e., a “to” strategy) or at some point well into retirement (a “through” strategy).

“While the ‘to’ approach for glide paths focuses more concern on market volatility on or around the target date, the ‘through’ approach focuses on making sure the investor doesn’t run out of money during retirement,” Mathew Jensen, director of target-date strategies at Fidelity Investments and a co-author of the paper, tells PLANSPONSOR. 

The approach Fidelity advocates, Jensen says, is to have a glide path that lasts over an investor’s entire life, not just their career, to make sure the income generated by such target-date investments fulfills the economic needs that occur throughout retirement.

“Allocation needs to be managed for a person’s entire lifetime and for an improved outcome,” Andrew Dierdorf, co-portfolio manager of Fidelity Investments’ target-date strategies and co-author of the paper, tells PLANSPONSOR.

Dierdorf and Jensen suggest to-retirement strategies tend to maintain a lower average exposure to asset types with higher historical risk, such as equities, both during an investor’s career and at the target retirement date. Conversely, they explain, through-retirement strategies tend to maintain a higher exposure to riskier assets during the savings years, at the target retirement date, and for several years through the retirement period.

Jensen says the post-retirement behavior of an investor is important to consider when choosing a glide path. Dierdorf reminds investors that, given current longevity estimates, their retirement could have a very long time horizon, on the order of 20 to 30 years, suggesting an individual's portfolio will need to keep growing long into retirement.

“You need to take a holistic view that encompasses both the pre- and post-retirement periods, rather than just post-retirement by itself,” Dierdorf says.

Given this, a “to” strategy may not be the best bet, say Dierdorf and Jensen, since exposures would become steadily more conservative as the investor reached his target date. While investments under a “through” strategy would also become more conservative as time goes on, say the two co-authors, the time frame would be more extended, factoring in the decades spent in retirement and potentially generating more lifetime income than a to-retirement strategy would. The suggestion goes against research published recently by other providers, which suggests the lower lifetime risk exposure of a to-retirement TDF makes the most sense for workplace retirement investors (see “BlackRock Argues To-Retirement TDFs are Best”).

The paper highlights the fact that a “through” strategy seems to work better for those with five years or more until they reach retirement. Jensen explains, “This has to do with the slope or rate at which an investor’s portfolio is de-risked. With a to-retirement strategy, the rate of de-risking and the related selling of equities is more rapid than with a through-retirement strategy.” Another disadvantage of using a “to” strategy, says Jensen, is that when there is a market drawdown, such as the recent recession, investors will likely not gain as much from a subsequent recovery due to the ever-more-conservative nature of the investments they hold.

The paper further explains that glide path slope refers to the year-over-year change in the equity allocation specified in the strategic yearly asset allocation. For a TDF, this means the fund is reducing its equity allocation on a periodic basis by selling equities and buying another asset class, typically bonds, as the fund’s investment horizon nears. A steeper slope means that the equity allocation is declining by larger amounts over a measured period. A glide path that has a steep slope is said to be de-risking faster than one with a more gradual slope, though it also risks locking in significant losses if a large equity market decline occurs during the steep segments of the glide path.

Overall, the steep slope of the “to” glide path during the decade prior to retirement may negate some of the risk advantage associated with the lower equity allocation measured at the target retirement date, say Jensen and Dierdorf. Their research suggests that for two investors with identical amounts to invest who enter a target-date strategy late in their working lives—one selecting a through-retirement strategy and the other a to-retirement strategy—the “through” glide path would be more likely to provide a higher level of wealth at retirement. 

Given all of these factors, Jensen and Dierdorf conclude that investors may fare better, over the long term, by using a “through” strategy rather than a “to” strategy.

A copy of the paper can be downloaded here.