Another Aspect of Market Risk

Understanding sequence of returns risk in target-date funds
Rich Weiss

Timing is everything, as the old saying goes, and that is especially true when timing retirement. In fact, although saving and investing for retirement is a long-term plan, the returns your portfolio receives in the last few years leading up to retirement can dramatically influence your portfolio and therefore replacement ratio. Alison Cooke Mintzer, Editor-in-Chief of PLANADVISER, spoke with Rich Weiss, Senior Vice President and Senior Portfolio Manager for the asset-allocation strategies at American Century Investments®, about the need to evaluate and consider sequence of returns risk when reviewing target-date funds (TDFs).

PA: What role do you see target-date funds playing in a retirement plan?

Weiss: A central role. Target-date funds have become the default vehicle in many if not most defined contribution (DC) plans, and for good reason. They offer prudent diversification and lifecycle investing. They are a critical part of a retirement plan no matter what the level of participant sophistication.

The participant’s level of investment sophistication, how their assets are split, how well or poorly they’ve saved over the years and therefore need to withdraw in retirement—these are all elements to help decide what type of asset allocations are appropriate. In a participant’s retirement plan, target-date funds could be the sole vehicle for investing. On the other hand, it could just be a small portion, depending on the participant’s other assets or inheritances, et cetera.

PA: What are the participant behaviors that are most beneficial to investing in target-date funds?

Weiss: The ideal behaviors that would be most beneficial are those that line up with the assumptions made in target-date funds or lifecycle investing in general, which are early and consistent contributions to your savings—in whatever plan you’re participating—and the “buy and hold” mentality, a “stick-to-itiveness.” Those are the behaviors that would be the most beneficial to investing in general, and it applies to target-date funds as well. Because target-date funds do have a process of de-risking in their asset allocation systematically over a lifetime, the best behavior would be one that allows the target-date fund to do what it was intended to do and to not second-guess it.

PA: How does a plan sponsor or adviser decide what target-date fund suite is right for a particular plan? What are those determinants?

Weiss: There are two main groups of determinants: those that are plan specific and those that are target-date fund specific. On the former, we’re talking about the demographics and characteristics of the participants in the plan themselves. Do they have a defined benefit (DB) plan? Are they professionals? Are they well-saved in general or high-income earning? Are their earnings variable or are they fairly steady and secure?

On the other hand, you have to match that information as best you can with the target-date fund specifics, and we compete on a number of different levels: glide path, fees, whether we’re active or passive or do tactical asset allocation, et cetera. No target-date fund is going to be able to address each and every individual participant’s needs, but you hope that you hit the broadest range of participants appropriately.