How Target-Date Fund Providers Determine the Glide Path
You can read how target-date funds work to familiarize yourself with this class of mutual funds.
Providers take a number of factors into play when determining a fund’s glide path.
- Contribution Potential – Providers will often consider how much their shareholders might contribute when determining the glide path. High earners and significant savers may be willing to invest more aggressively given that their larger future contributions could more quickly make up for short-term market losses.
- Anticipated Retirement Age – If the shareholder base of the fund, on average, is expected to stay in the workforce longer, it allows the provider to take a more aggressive stance given the number of years remaining until retirement.
- Expected Rate of Return – Earning higher returns requires taking on greater risk. If the expected rate of return on a target-date fund is higher, it will likely require a heavier allocation to equities or international securities in order to achieve it.
- Preferred Income Replacement Ratio – The general rule of thumb is that you should aim to replace 80% of your preretirement income when you leave the workforce. Investors who wish to aim for closer to 100% will need to achieve higher returns to meet that goal, something that a more aggressively allocated TDF could help with.
- Expected Lifestyle After Retirement – A retirement filled with lots of travel plans, for example, will cost much more than one spent largely at home. A more aggressive fund allocation might be necessary to try to enhance returns to help fund those goals.
Check out our Retirement Fund section to know the different types of pre-packaged target-date funds.
Why Go the Aggressive Route
- Low Interest Rate Environment – Income seekers have a more challenging time finding yield in low-interest rate environments. In response, many will choose to accept higher risk in an attempt to find the yields they’d ordinarily be able to get in a normal rate environment. TDFs may also opt for higher risk securities for improved yields.
- The Potential Benefits From Tax Reform – One of President Trump’s campaign platforms has been lower corporate taxes and fewer regulations on businesses. These agenda items, if they come to fruition, should drive earnings to the bottom line as well as free up capital for further investment in the business. Both of these should benefit the stock market.
Know the pros and cons of target-date funds.
Considerations When Choosing an Aggressive Target-Date Fund
- Risk Appetite – The equities markets, both domestic and international, can be volatile. If the idea of experiencing the 10-20% losses that may occur from time to time makes you uncomfortable, staying away from a more aggressive TDF may be advisable.
- Life Goals After Retirement – If you have plans that potentially involve heavier spending, you may want to stay away from more aggressive TDFs to help ensure that the funding for your plans is there.
- Other Existing Retirement Options – If you’re investing through a 401(k), your options may be more limited. Other more conservative target-date funds or index funds may be more suitable.
Check the questions that you should ask your target-date fund provider.
The Bottom Line
Be sure to follow our Target-Date Funds section to make the right investment decision.
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