Introduction
Target Date Funds (TDFs) offer participants an “all-in-one” professionally managed and diversified asset allocation solution that automatically becomes more conservative by derisking out of equities as the target retirement date approaches. Due to their simplicity, many plan providers have adopted TDFs as the default investments for their participants. Participants might not fully understand their risk tolerance but can generally identify the approximate year in which they plan to retire. They are relatively easy to understand, and a one-size-fits-all approach leads providers to prefer them to other default options such as target risk funds, balanced funds, and managed accounts.
Understanding six key factors of TDF construction—also referred to as glide path design—can help fiduciaries and plan designers make informed decisions that enhance retirement outcomes for participants, ensuring that the glide path strategy effectively balances growth potential with risk management over the course of an individual’s savings and spending timeline. This comprehensive approach to glide path design supports the fiduciary’s responsibility to act in the best interest of plan participants and helps to foster a sense of confidence and security among participants as they save and plan for their retirement years.
Of course, to effectively enhance retirement outcomes, glide paths operate within a broader ecosystem of stakeholders, each playing a crucial role in the process (Exhibit 1).
- Governments and regulators establish guidelines and standards to ensure transparency and safeguard investors’ interests, providing a reliable framework for retirement planning.
- Pensions/operators design and provide retirement investment plans with Fiduciary oversight offering structured pathways to secure financial futures for participants.
- Asset managers design, manage, and advise on glide path strategies, tailoring them to meet varying risk tolerances, constraints, and time horizons.
- Custodians and recordkeepers ensure accurate tracking and management of retirement assets, maintaining the integrity of participants’ accounts.
- In some regions, employers play a pivotal role by offering these retirement plans to their employees, facilitating access to structured savings options, and participating in employee education.
- Participants themselves engage with these glide paths, making informed decisions to align their retirement goals with the available strategies.
Together, these stakeholders collaborate to create a comprehensive framework that supports individuals in achieving optimal retirement outcomes through well-structured glide paths and TDF design (Exhibit 2).
1. Defining your objectives
The first step in designing a TDF is defining the plan’s objectives.
This involves examining participant demographics, such as age, income levels, investment behaviors, and the overall ecosystem in which these assets are growing, such as regulations and social insurance. These factors shape considerations like return expectations, volatility management, and risk exposure at retirement, allowing the glide path design to align with these goals. Participants encounter multiple risks during their saving and spending phases. These include, but are not limited to, the risk of loss of principal, particularly acute near or during their spending years, the risk of insufficient savings during their working years, inflation risk, interest rate risk, and general market risk. Exhibit 3 outlines the phases of a participants saving and spending lifecycle with their approximate associated ages.
This process involves determining whether the plan’s objective is focused on income replacement at retirement, or a lifelong investment strategy that maximizes savings throughout retirement, and/or is designed to provide a steady income stream during retirement.
Given the global demographic shift, we have seen a significant focus shift to the spending phase.
Spending in retirement is a critical phase where individuals transition from saving and accumulating wealth to drawing down their savings to fund their retirement lifestyle. This phase requires careful planning and strategy to ensure that retirees can maintain their desired standard of living without outliving their resources. The focus during the spending phase is determining the appropriate annual withdrawal amount. Designing a glide path that incorporates the spending phase requires a comprehensive approach that balances the need for income with the preservation of capital, considers individual circumstances, market conditions, retiree preferences, changes to social insurance, and life expectancy. Attributes to evaluate when designing a solution that supports spending include fee transparency, liquidity and control of the funds, and certainty of time frame for the income stream to name a few. Exhibit 4 offers a framework for considering spending options.1
In summary, reviewing participant demographics and behaviors, such as employee participation rates, and contribution patterns both from the participant and employer on a regular basis can provide plan designers with valuable insights to update the glide path and set realistic and achievable retirement outcomes.
2. Glide path strategy
Designing an effective glide path strategy is crucial for successful retirement outcomes as it is the primary driver of the participant experience. Determining the glide path strategy involves analyzing how asset class exposure changes as the glide path approaches its target retirement date. The logic behind most glide paths is that younger investors can handle more risk to maximize return potential, while older investors need to focus on preserving their assets. Evaluating how the glide path affects outcomes involves considering diversification and equity exposure (Exhibit 5).
Issues to assess include how the glide path addresses growth, volatility, and plan goals, ensuring it matches participant risk tolerance and, perhaps, volatility of contributions throughout their savings phase. Additionally, understanding the speed of transition from higher risk/reward investments to lower risk/reward investments is crucial, as it can significantly impact the portfolio’s ability to manage growth and volatility efficiently. At the end of the glide path, balances are at their highest, contributions have ceased, and spending down of the assets has begun. Assessing the TDF for its focus on avoiding losses at this critical time is important.
Glide paths should typically be reviewed on a regular basis to ensure they remain aligned with the plan’s objectives, market conditions, evolving regulatory landscape, and investor needs. An annual review of the glide path is a best practice. This allows for an assessment as to whether the current asset allocation strategy is still appropriate given changes in market conditions, economic forecasts, and demographic trends—and ensures that the funds continue to meet their investment objectives and serve the best interests of their participants.
3. Asset allocation and diversification
Asset allocation decisions can be based on historical asset class characteristics or forward-looking assumptions, each having a significant impact on performance. Determine whether the glide path design is intended to maximize growth or minimize volatility with a particular asset mix. These decisions should align with the plan’s objective for the glide path while balancing regulatory constraints.
Developing an effective asset allocation strategy requires balancing investment insight and expertise, using tools like modern portfolio theory, glide path simulations, and leveraging time-tested long-term capital market assumptions to evaluate risk and return expectations for the future. The efficient frontier concept is often used to optimize investment combinations, providing the greatest expected return for a given level of risk. Exhibit 6 reflects the forward-looking return expectations for a diversified 60/40stock/bond portfolio as implied by J.P. Morgan Asset Management’s 2025 Long-Term Capital Market Assumptions.
Including globally diversified asset classes in the glide path design such as real assets, high yield bonds, and emerging markets equities and debt can enhance return efficiency and reduce overall risk, provide opportunities for growth by capturing returns from different segments of the global markets, and help to ensure that the glide path is well-positioned to deliver consistent performance across different economic cycles.
Broader diversification is achieved through a disciplined framework to analyze which asset classes provide additive benefits to a strategy. Important factors to consider include liquidity, transparency, economic value, volatility, and fees.
By analyzing various global asset-class weight combinations, investment managers can identify portfolios that capture the highest return potential based on a particular risk profile, and by continuously monitoring and adjusting the asset allocation strategy on a regular basis, can respond to changing market conditions and participant needs. Exhibit 7 shows that relying on any one asset class can result in outsized gains or losses. The diversified Asset Allocation portfolio balances return and loss potential to deliver a smoother investment experience for participants saving and accumulating wealth for retirement.
4. Manager selection
Manager selection involves analyzing how different underlying investments can be used as building blocks to gain efficient access to asset classes, whether active, passive, or a blend of both approaches, which can affect diversification and potential returns.
Due diligence criteria for selecting underlying investment strategies involves evaluating the investment manager’s opportunity set, a focus on correlations of those strategies, and the ability to select a mix of strategies that consistently contribute to uncorrelated sources of return over the benchmark.
TDFs can use as few as one underlying strategy to gain exposure to an asset class if the investment manager believes it is representative enough to offer appropriate diversification and potential additive benefits to the overall portfolio.
A comprehensive approach to portfolio construction ensures that the unique characteristics and objectives of each asset class are considered, leading to a more robust and resilient portfolio.
As with the glide path and other factors, regular continuous evaluation and adjustment of the portfolio construction process can help ensure that the TDF remains responsive to changing market conditions and participant needs, delivering a more effective and efficient investment solution for participants.
5. Rebalancing strategy
A rebalancing strategy focuses on maintaining the portfolio’s strategic asset allocation by minimizing tracking error which affects the portfolio’s deviation from its long-term strategic allocation. Cash flows also provide rebalancing opportunities and require management to limit portfolio turnover required to meet withdrawals.
Systematic rebalancing is essential to maintaining the portfolio’s risk/reward profile, and the investment manager must make active decisions about the acceptable variance in weightings for each asset class.
6. Fiduciary responsibility and oversight
Developing a prudent glide path design and construction process, documenting the evaluation criteria, and monitoring the process are critical. This involves examining the types of investments, asset allocations, risks, and costs most appropriate for the participants in the context of the objective. The investment policy statement should detail key areas such as stakeholder responsibilities, plan goals, risk/reward profile, due diligence, costs, and ongoing monitoring efforts.
Fiduciaries must determine if their glide path design is appropriate for their participants’ best interests, considering the plan’s desired purpose for it and the characteristics of participant demographics.
Target date funds can be difficult to design and evaluate given the multiple parameters that require understanding and review. Asset class inclusion decisions, percentage of risk assets along the glide path, slope and ending point of the glide path, and post-retirement structure and objective are some considerations. In addition, the providers, investors, technology, operational practices, and communications support all come under review or regulatory oversight.
Typically, evaluation criteria include a broad benchmark and a custom benchmark. Peer comparisons are commonly discussed (although the goal of each fund in the peer universe varies, so this can be misleading), and should be evaluated in the context of long-term performance, Sharpe Ratio/other quantitative metrics, etc.
This thoughtful approach to fiduciary responsibility ensures that providers are well-equipped to navigate the complexities of glide path design and monitoring, providing their participants with a more effective and efficient investment solution that can deliver optimal outcomes.
Conclusion
By evaluating these six factors, providers can develop effective glide path design and oversight criteria to determine the most prudent fit for their participants. This process involves understanding the plan’s objectives, participant characteristics, and the investment manager’s approach to global asset allocation and risk management.
In addition, an effective communications program can help participants determine if the glide path is right for them by explaining the outcomes it is designed to deliver. Ongoing communication efforts can also help participants set realistic retirement goals and understand how critical their saving patterns are to achieving these goals, enhancing their overall retirement readiness and financial security.