The extreme market volatility in recent weeks has put a number of passive investment approaches under scrutiny. Among these is target-date funds (TDFs). Though activity in these funds has exploded in the last few years, TDFs suffer from lock-in, making them unresponsive to the kind of changing market conditions we’ve seen lately, or to changes in personal situations. In addition, because of their laser-like focus on maturity date alone, TDFs are often composed of mediocre or poor underlying investment strategies.
Target-Date vs Target-Risk
According to Robert Michaud, CIO at New Frontier Advisors, investors should focus more on targeting risk than targeting a specific date. Michaud points out that studies have shown that the overall lifetime risk taken by the “glide path” – the way the asset allocation of a portfolio changes over time - is the most important determinant of expected wealth when the targeted date is reached.
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- Almost as important in determining realized wealth at the target date is market performance, specifically of the asset classes with greater exposure within different time periods along the glide path. This fact justifies a more dynamic strategy of tailoring risk exposure to actual market conditions as time passes.
- Retirement funds should not be locked in and left alone, forgotten and unresponsive to market conditions. Assets should instead be thought of as building blocks to be assembled on the fly, rather than locked-down into unchangeable trajectories. They should reflect a customized investment plan that is responsive to both market and personal considerations.
- In addition, target-date funds are often built on poor underlying strategies that ignore correlations between assets. An effective investment program should instead be constructed from globally diversified risk-managed funds that balance asset classes appropriately and manage risk effectively.
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