A target-date fund is a type of managed fund where the the portfolio is gradually de-risked towards 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 an appropriate approach, then susuch a fund can offer 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. When annuity rates were very low, some people rejected annuities out of hand; drawdown became far more popular. But as one ages, the rates on offer tend to rise; eventually a point may be reached when the potential guaranteed annuity income exceeds a commonly cited drawdown rate. At that point, a key consideration might be the importance of leaving 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 degree of investment risk that may be appropriate for your circumstances will no doubt vary over time. But it may well not be a simple glidepath to your planned retirement date. Many people choose to 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 reasonable for some to increase risk over time, as counter-intuitive as this may sound.
A tailor-made approach
How can you understand what risk trajectory might suit your circumstances? This is one of the things that the EvolveMyRetirement® tool can help you understand. It arrives at a risk trajectory based purely on how well randomised outcomes meet your long-term objectives, taking uncertainty into account. Based on a generated risk trajectory, you can select investments consistent with it, 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 risk trajectory generated by our tool. Provided you haven’t ruled out annuities completely from our tool’s strategy generation, it will indicate if and when annuities appear aligned with your stated goals, and to what extent. It has no built‑in biases, but assesses outcomes only. The generated risk trajectory will be compatible with the generated annuity strategy (if any).
So target-date funds may or may not align with your objectives; and if so, not necessarily as a direct glide path to retirement.