About target-date fund glide paths—a key to asset allocation in a 401(k)

TDFs have become increasingly popular for people seeking a simple investment strategy to help them accumulate savings while managing risk. The funds emerged in the 1990s, and they took a big leap forward in 2006, when Congress allowed them to serve as a qualified default investment alternative (QDIA) in 401(k) plans for automatic enrollees who don’t specify how to invest their money. By the end of 2020, assets in target-date mutual funds and collective investment trusts grew to a record $2.8 trillion—up about 20% from the previous year.²

How TDFs work

While there are many considerations in choosing one for your participants and plan, the products offer an appealing level of simplicity. A participant can choose a fund with a target date in its name—say, a 2030 or 2055 fund—that roughly coincides with the year of their anticipated entrance to retirement. Over the years, the fund’s manager adjusts allocations to stocks, bonds, and other assets as investor risk tolerance changes with the target date approaching. The products may appear somewhat commoditized because they all have target years in their fund names, but they vary widely in how they pursue their objectives.

The glide path and how it affects asset allocation

Perhaps the most important distinguishing feature of any TDF is its glide path—which is the prescribed asset allocation adjustments the fund makes to balance growth potential with risk management as an investor ages.

For example, TDFs typically keep most assets invested in stocks during the early and middle stages of an investor’s working years, when retirement is likely to be decades away. At that point, most funds’ glide paths offer equity exposure of around 80% to 90% of the overall portfolio, with the rest typically in bonds. A typical glide path provides around 70% to 80% equity exposure when the target retirement date is a couple decades away, and then 50% to 65% when it’s 10 years away. At the target retirement date, most glide paths keep equity allocations at around 40% to 55%, to help provide for continued growth.

A sample TDF glidepath

The rationale for the changing equity exposure? It has to do with stocks’ history of outperforming bonds and short-term investments in the long term. When equities experience market downturns, younger investors are typically in a better position to ride out the volatility than those close to or in retirement.

For those in their 50s and 60s, ill-timed market losses can be especially painful, as they can take a significant bite out of portfolios just as near-retirees face the prospect of tapping their invested savings to cover living expenses. So the equity exposure glides down a path determined by the fund manager, starting high in the early career, and ending low at retirement.

While this may describe the typical glide path, they vary by fund family. As a plan fiduciary, it’s important to understand what the differences are and the reasons for them, since a glide path will affect the fund’s risk and performance.

“Through” and “to” approaches to glide path design

When they reach the target retirement date, glide paths generally take one of two approaches to address very different objectives.

Most are “through” glide paths, so named because they continue to gradually ease back on equity exposure through the first 10 to 20 years of an investor’s expected retirement. Generally, through glide paths offer equity allocations of around 25% to 50% during the first decade or so of retirement, and then remain static with slightly less equity exposure once the investor has been retired for a couple decades. This approach aims to address the needs of investors who may live into their 80s, 90s, and, perhaps, beyond.

The thinking behind through funds is that an investor should stick with a consistent long-term strategy that adjusts asset allocation well into retirement, rather than remaining static. With today’s increasing life expectancies, continued exposure to stocks can help address longevity risk—or the chance that they’ll outlive their savings.

Another approach is the “to” glide path, which maintains a static asset allocation once an investor reaches the target retirement date, resulting in a flat line on a chart depicting a glide path. The underlying idea here is that the entrance to retirement is a decision point, at which the investor may wish to transfer assets held in a TDF into other vehicles designed for retirees. In the transition to retirement, many investors move invested savings from IRAs, 401(k)s, or other workplace savings plans into a unified account managed by a financial professional, and a TDF may not be deemed the best option to meet an individual’s retirement needs.

Two glide path charts, each designed to address a different investor need

Preparing your participants, and 401(k) investment lineup, for the journey ahead

Understanding a manager’s glide path design and philosophy can go a long way toward helping you choose the right family of TDFs for your participants. But, of course, there are other factors as well—manager tenure, industry ratings, risk-adjusted performance, and the managers’ willingness to invest their own money in the funds they’re running.²

And regardless of which funds you offer, be sure to provide the education and guidance participants need to understand TDFs, how glide paths work, and how to use them as part of their personal retirement strategy.

1 "2021 PLANSPONSOR Defined Contribution Plan Industry Report," PLANSPONSOR, 2021. 2 "2021 Target-Date Strategy Landscape," Morningstar, Inc.