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No Such Thing as Average: Designing Glide Paths for Target Date Funds

Joseph C. Flaherty, Jr., Chief Investment Risk Officer
Ryan E. Mullen, CIMA, ARPC, Senior Managing Director, Head of Defined Contribution Investments
Derek W. Beane, CFA, Director, Investment Products

A widespread industry practice is to create target date fund glide paths based on assumptions about a representative participant profile.1 Yet defined contribution plan demographics vary widely with respect to participant saving habits, income and outside retirement assets. Consequently, we don’t believe that a truly representative participant profile exists.

To illustrate the wide-ranging characteristics of defined contribution plan participants, we look at how much they have saved for retirement, how much they contribute to employer sponsored plans and how much they say they might need to sustain their lifestyle in retirement.

As we see here, the amount of retirement savings participants have accumulated in their employer-sponsored retirement plans is broadly dispersed, with most participants deviating from the average 401(k) plan balance of $72,383 and the median balance of $18,433.

*MFS, through Research Collaborative, an independent research firm, sponsored an online survey from February 4 to February 11, 2014, of 1,000 defined contribution plan participants in the US between the ages of 20 and 69 who are employed and have at least a $1,000 balance in a plan with their current employer. MFS was not identified as the research sponsor.

Similarly, the percentage of pay that participants contribute to their defined contribution plans varies widely around a mean rate of 8.4%.

Finally, the amount of assets workers say they need to accumulate by the time they retire varies broadly based on their profession, their desired lifestyle and even their location.

If an investment manager were to design a glide path for a representative participant based on the dimensions we have just highlighted, that glide path would be optimal only for one who contributes at an 8.4% rate, has approximately $72K in retirement savings and believes that he or she needs to accumulate roughly $650K by retirement. Clearly, such a profile represents a very small set of participants.

Thus designing a glide path based on a representative participant profile is rather like creating one average size shoe to fit an entire population. In most cases, it won’t be a good fit. Instead of focusing on a representative participant, we believe glide paths should be designed to suit most investors in a plan based on two key principles:

  1. Appropriately balancing capital appreciation and principal preservation objectives as a function of time to the target date
  2. Maximizing the sustainability of a participant’s retirement investments in the event of market shocks.

1 Target date funds allow savers to choose the time horizon that best matches their specific financial goals consistent with the approximate retirement year in the fund’s name. These funds automatically re-balance a portfolio’s asset mix over time, for example, shifting from an aggressive to a conservative profile as participants move closer to their retirement date. The principal value of the fund options are not guaranteed at any time; the funds’ objectives and investment strategies change from one target date to another. A glide path is the fund’s predetermined plan for changing the fund’s mix of investments (“asset allocation”) over time, from being more heavily weighted toward stocks to more heavily weighted toward bonds.

The views expressed are those of the author(s) and are subject to change at any time. These views are for informational purposes only and should not be relied upon as a recommendation to purchase any security or as a solicitation or investment advice from the Advisor. This content is directed at investment professionals only. 37637.2 

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