target-date

A target-date fund is a type of managed fund where the plan is to sell it on a specific date. Other common names for it are a lifestyle fund or life-cycle fund. Unlike most managed funds, the risk exposure of a target-date-fund gradually reduces over time. The starting risk depends upon one’s risk tolerance. The final risk is normally very low, so as to provide more certainty at the time of sale. One way of looking at a target-date fund is as a way of putting an investment on autopilot over a predefined glidepath.

In the past, the main use of target-date funds were in pension plans. At the point of retirement it was normal to buy an annuity. The idea of using these funds was to mitigate the risk of a sudden market downturn just before retirement. Another use nowadays is for funding future planned spending, such as children’s’ tuition fees. Here’s a good overview (and critique) of target-date (lifestyle) funds.

A holistic target-date

For retirement planning, the use of target-date funds only makes sense if the intention is to eliminate as much risk as possible by retirement. If you believe this is the right strategy, then such a fund is great convenience. But is it the right strategy?

It is no longer mandatory to buy an annuity at your retirement date, or indeed at all. This doesn’t mean that buying one is necessarily always a bad idea. With annuity rates currently very low, some people reject annuities out of hand; drawdown has become far more popular. But as one ages, the rates on offer will rise; eventually a point may be reached when the potential risk-free annuity income exceeds the ‘safe’ drawdown rate. The only reason not to buy an annuity would then be one’s desire to leave a legacy. One could address this by buying an annuity with just a portion of one’s drawdown funds.

Whether or not you consider an annuity a future option, the optimal degree of risk you should be taking with your investments will no doubt vary over time. But it may well not be a simple glidepath to your planned retirement date. Most people should reduce risk over some time period. But for some (typically wealthy) people there’s no benefit in reducing risk. And for others (typically those with few assets to start with), it may even be beneficial to increase risk over time, as counter-intuitive as this may sound.

A tailor-made approach

How can you know what risk trajectory is right for you? This is one of the things that the EvolveMyRetirement® tool can optimise for you. It arrives at a risk trajectory based purely on how well randomised outcomes meet your long-term objectives, taking uncertainty into account. Based on an appropriate risk trajectory, you can select appropriate investments, ideally with the help of an independent financial adviser. Over time, you can rebalance your investments to be in line with the level of risk appropriate for your age.

As your personal circumstances and the economy change over time, so may the optimal risk trajectory as determined by our tool. Provided you haven’t ruled out annuities completely from our tool’s optimisation, it will also guide you as to if and when you should consider buying annuities, and to what extent. Its optimisation has no biases, but looks purely at outcomes. The optimised risk trajectory will be compatible with the optimised annuity strategy (if any).

So target-date funds may or may not be appropriate for you; and if so, not necessarily as a direct glide path to retirement.

Target-Date Funds: The Answer To Managing Risk?
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