What is a target date fund?
A target date fund provides a professionally managed glide path to retirement in a single fund. The fund’s asset allocation gradually changes over time, becoming more conservative as the target retirement date approaches.
Each member invests in the fund with the target date closest to when they plan to retire. For example, a member who plans to retire in 2049 would invest in the 2050 fund.
What is a glide path?
The glide path is the changing mix of assets that the fund invests in as it progresses to its target date.
MYTH: Target date funds are just the same as lifecycle structures
In a lifecycle structure, individual funds are combined, typically by a consultant. Members are rotated out of risk assets mechanistically by the platform or administrator, according to their date of birth, as they approach their retirement date.
In contrast, target date funds are holistically managed by a single manager. Asset allocation changes gradually, rather than mechanistically, along the journey to retirement. Many target date funds employ active asset allocation, meaning that they can be more market aware, and the glide path can evolve more easily as member behaviour changes, new investment opportunities arise or regulations change.
REALITY: Target date funds represent a significant evolution from lifecycle structures.
MYTH: Target date funds tie members into a fixed retirement date
While lifecycle structures target not just a specific year but a specific date, target date funds are designed to provide the right asset mix for members retiring over a period of time—typically three to five years.
Defined contribution (DC) structures need to be flexible enough to accommodate people if their retirement plans change. In lifecycle structures, members who near retirement and find that they need to keep working may face difficult decisions about where to allocate the money they currently have in bonds and cash. In target date funds, they can simply switch to a fund with a later target date and will have an appropriately diversified portfolio for that stage of their working lives.
REALITY: Members can easily switch to a fund with a later target date
How a target date fund works
This chart explains the journey to retirement taken by target date funds, and shows how the glide path works in practice. At the beginning of the journey, the target date fund will contain a combination of investments—mainly stocks, but also bonds and cash. This blend changes as the target date gets closer.
The chart shows a typical target date fund glide path (the changing mix of assets that the fund invests in as it progresses to its target date). Along the journey to retirement, target date funds can adjust their asset mix to reflect regulatory developments, changes in member behaviour, evolving long-term market conditions and new investment opportunities.
MYTH: Target date funds can’t adapt
Target date fund glide paths map out the whole of a member’s journey to retirement—but this journey is flexible, not fixed.
Because they are managed by a single manager, target date funds can respond quickly to changes such as new regulation or shifts in savings patterns. Changes to the glide path can be implemented quickly and without triggering the member communications that may be necessary in a lifecycle structure.
REALITY: Target date funds are highly flexible
MYTH: Target date funds are too complicated for members to understand
DC savers often lack the time, knowledge or interest to digest complex information about investment strategies. Target date funds are simple to understand—one fund, providing a professionally managed journey to retirement.
Rather than making complicated decisions about the asset mix they need in their pension portfolios, target date fund savers make one simple choice: the date they expect to retire. Plan sponsors can then focus their communication efforts on the area that matters most: improving savings rates.
REALITY: Target date funds are easy to explain
MYTH: All target date funds are the same
All target date funds are not created equal. Different funds have different objectives—to outperform a benchmark, maximise the average pot or target a certain level of replacement income at retirement.
Different target date funds have different degrees of diversification, different derisking periods and different levels of equity allocation along the journey to retirement. Some are fully passive, some are fully active and others fall somewhere in between—so it’s important to understand how each target date fund works.
REALITY: Target date funds can vary widely
TARGET DATE FUNDS ARE:
- A significant evolution in the DC default
- Flexible for members
- Designed to adapt to changing environments
- Easy to communicate
- Not all created equal