While target-date funds have become commercially successful and are often the default investment vehicle in retirement plans, they have also received flack for not being sufficiently well diversified and that a glidepath with declining equity allocations over time is not optimal for all participants.

However, according to a recent paper by T. Rowe Price in The Journal of Portfolio Management, as recordkeeping technology continues to evolve, there is increasingly more opportunity for target-date funds to become more personalized, down to the participant level.

Kobby Aboagye, an investment quantitative analyst in the multi-asset division at T. Rowe Price, and one of the authors of the paper, explains that TDFs are designed based on a participant’s perceived retirement age and the assets typically begin with a high allocation to equities early in their career and then gradually shifts toward a higher allocation to bonds as the participant approaches retirement.

TDFs are typically constructed and designed using data and assumptions based on the broad U.S. population, which assumes a retirement age of 65.

“But you could have a plan for, say, first responders of police and fire service, who typically [do] not work to age 65 and who typically retire at age 55 or earlier,” Aboagye says. “So, we have to design target-date funds that cater to that plan’s unique demographics.”

The authors of the paper argue that the next stage of TDFs will be to introduce further personalization, beyond age, to include dynamic asset allocation and spending capabilities. T. Rowe developed a model that uses the same theoretical foundations used to develop popular TDFs but also included other participant data like salary, account balance, contribution and match rates, Social Security, risk tolerance and more.

For this personalization to take place, Aboagye explains that recordkeeping systems need to be able to have the ability to gather a lot more information about individual participants. In addition, once the system is built to collect this data, Aboagye says the recordkeeping system must be able to deliver personalized advice and implement it on the participant’s account.

Some of the more specific information, such as salary, savings and match rates and current account balance, can be found on most recordkeeping platforms by default, and the recordkeeper can come up with a personalized TDF for the participant based on that data. However, Aboagye says an even more tailored solution can be offered if a participant decides to engage and provide more information.

“For example, we may assume a retirement age for a participant, typically age 65, and also assume [an] age when the [participant] is going to start collecting Social Security,” Aboagye says. “But the participant can go in there and tell us, ‘No, I actually plan to retire at age 70,’ … or [that they] want to collect Social Security as late as possible.”

Aboagye adds that a participant can also specify how much risk they want to take on, which would enable more personalization. He emphasizes that recordkeeping platforms need to allow participants to interact with the engine itself so that it can collect more than just default information.

“From my point of view, the most important advancement [that recordkeepers can offer] is the ability … to integrate different platforms and [work with] different internal departments and external vendors,” Aboagye says.

In terms of how the technology works, the recordkeeping system must work with an advice engine to provide personalized advice to participants. Under that hood is the asset allocations, Aboagye explains, as well as the portfolio construction where investment managers have to execute the trades.

“All these systems must be able to communicate with each other at scale, and also pretty fast,” Aboagye says.

One of the critiques of TDFs, mentioned in the paper, is the idea that TDFs are not well-diversified and deliver too much equity risk. However, based on publicly available information from various TDF managers, T. Rowe argued that these portfolios are well-diversified across domestic and international markets, style, size and asset classes (such as core bonds, high yield and international bonds). The only asset classes that are not typically included are illiquid alternatives, such as private equity, due to liquidity constraints on the defined contribution plan platforms.

Aboagye says an asset class that is getting a lot of buzz right now is cryptocurrency, and T. Rowe Price is still doing research into it as a potential asset class. However, he says it is hard to know whether crypto is just a fad right now or if it’s here to stay. He also says interest in it tends to skew toward the younger generation than those in older generations.

According to the paper, the next step in the evolution of TDFs will be to introduce retirement income solutions, including guarantees as needed. BlackRock’s LifePath Paycheck is an example of a solution that functions like a TDF and also provides a guaranteed income stream.