- To select a target-date fund (TDF) from among 105 in Morningstar’s database, think about the glide path.
- The glide path is a target-date fund’s recipe for asset allocation over time.
- A new tool can help retirement plan decision makers sort and find TDFs based on their glide path.
It was widely reported that internet searches for “banana bread” spiked during the early stages of the Covid lockdown. When baking banana bread, a list of ingredients is important. But the amount of each ingredient and how to mix the ingredients is also crucial to the outcome of your baking efforts.
When it comes to target-date construction, asset classes are the ingredients. Mixing them together is called asset allocation. But what’s the recipe? The glide path. It determines the mix, based on where an investor is relative to his/her investment time horizon. This is known as creating a strategic glide path.
Many to choose from
A search of the term “banana bread recipes” yields approximately 413 million results. A search of the term “target date glide paths” yields about 1.7 million results — not as many as banana bread recipes, but still an overwhelming number. The Morningstar Target Date Fund Landscape database contains 105 mutual fund and collective trust TDF glide paths that have long enough track records to be included by Morningstar.
With 105 choices of fund and CIT TDFs, it may be tempting to take the short cut and select one’s TDF based only on 3- to 5-year results, or maybe on brand name recognition. This would be like picking a baked good based on how it looks on the shelf without knowing the ingredients. It might look good on the outside but it may contain ingredients you do not like or, what’s worse, are allergic to. To avoid adverse outcomes, knowing the ingredients and how those ingredients are combined is crucial in TDF selection.
The concept of strategically allocating assets appears to date back to 500 A.D. At that time, it referred to land, merchandise, and liquid assets. The value of asset allocation in determining the variation/difference in two portfolios is addressed in a 1995 paper, “Determinants of Portfolio Performance,” which “asserted that asset allocation is the primary determinant of a portfolio’s return variability….” This work was followed up by William Jahnke in which he writes “investors should be more concerned with the range of likely outcomes over their investment planning horizon than the volatility of returns.” Jahnke went on to warn, “Fixed asset allocation solutions are inferior to analytically linking forward-looking strategic asset allocation solutions. . . . As the investor’s circumstances or market opportunities change, so also should the investor’s asset allocation.”*
The work cited above along with additional research serves as the foundation of the idea that investors are better served “gliding” along a strategic path during their working and investing lives rather than being anchored to a set allocation regardless of circumstances.
Taking a fiduciary view
With 105 TD glide paths to choose from, what is an investor to do? What about the plan fiduciaries who are personally liable for the process that leads to a selection of one path versus another? Yogi Berra, the legendary baseball coach, supposedly said, “When you come to a fork in the road, take it.” With 105 paths or “forks” to choose from, random selection is not advisable.
We are happy to announce the release of TargetDateVisualizer®. What TDV does is allow a retirement plan professional to help retirement plan decision makers examine the underlying asset allocation “ingredients” of all 105 glide paths in the Morningstar TDF data base. Each glide path is plotted according to its global stock sensitivity (represented by the MSCI All-Country World Index). Importantly, TDV measures sensitivity to stocks for both young and near-retirement investors.
TargetDateVisualizer® may help retirement plan decision makers examine the underlying asset allocation “ingredients” of all 105 glide paths in the Morningstar TDF data base.
Using the tool, the TDV universe of 105 glide paths can be narrowed by answering three basic questions about the plan sponsor’s preferences for each end of the glide path and the sponsor’s definition of TDF “success.” This process will lead to a filtered choice of paths that share the characteristics the sponsor has indicated it is looking for via the sponsor's answers to the questions. From the filtered list a subset of TDFs can be selected for additional analysis.
If you know you don’t like a certain ingredient, why buy it? If you don’t think ingredients should be combined a certain way, why follow that recipe? If you know the ingredients and how to combine them before selecting your TDF, your odds of reaching your desired outcome are likely higher than if you choose based on recent results. TDV can help you better understand the TDF ingredients and recipe you are considering.
Click here to sample TargetDateVisualizer®.
*Enterprising Investor, David Larrabee, CFA Institute, February 2012.
For informational purposes only. Not an investment recommendation.
This material is provided for limited purposes. It is not intended as an offer or solicitation for the purchase or sale of any financial instrument, or any Putnam product or strategy. References to specific asset classes and financial markets are for illustrative purposes only and are not intended to be, and should not be interpreted as, recommendations or investment advice. The opinions expressed in this article represent the current, good-faith views of the author(s) at the time of publication. The views are provided for informational purposes only and are subject to change. This material does not take into account any investor’s particular investment objectives, strategies, tax status, or investment horizon. Investors should consult a financial advisor for advice suited to their individual financial needs. Putnam Investments cannot guarantee the accuracy or completeness of any statements or data contained in the article. Predictions, opinions, and other information contained in this article are subject to change. Any forward-looking statements speak only as of the date they are made, and Putnam assumes no duty to update them. Forward-looking statements are subject to numerous assumptions, risks, and uncertainties. Actual results could differ materially from those anticipated. Past performance is not a guarantee of future results. As with any investment, there is a potential for profit as well as the possibility of loss.
Diversification does not guarantee a profit or ensure against loss. It is possible to lose money in a diversified portfolio.
Consider these risks before investing: International investing involves certain risks, such as currency fluctuations, economic instability, and political developments. Investments in small and/or midsize companies increase the risk of greater price fluctuations. Bond investments are subject to interest-rate risk, which means the prices of the fund’s bond investments are likely to fall if interest rates rise. Bond investments also are subject to credit risk, which is the risk that the issuer of the bond may default on payment of interest or principal. Interest-rate risk is generally greater for longer-term bonds, and credit risk is generally greater for below-investment-grade bonds, which may be considered speculative. Unlike bonds, funds that invest in bonds have ongoing fees and expenses. Lower-rated bonds may offer higher yields in return for more risk. Funds that invest in government securities are not guaranteed. Mortgage-backed securities are subject to prepayment risk. Commodities involve the risks of changes in market, political, regulatory, and natural conditions. You can lose money by investing in a mutual fund.
Putnam Retail Management.